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13 views16 pages

Lec 4

labor

Uploaded by

brianmfula2021
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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ECO290E: Game Theory

Lecture 4: Static Games with Continuous Strategies

1 Lecture 4 2013 Winter


Review of Lecture 3
} There are at least four reasons why we can expect
Nash equilibrium (NE) would realize.
1. By rational reasoning
2. Being an outstanding choice
3. A result of discussion
4. A limit of some adjustment process
} In some cases, NE can be reached merely by
rationality.
} Focal point: Class room experiment
} Dominant strategies: Prisoner’s Dilemma
} Iterated elimination of strictly dominated strategies

2 Lecture 4 2013 Winter


From Discrete to Continuous Strategies
} Discrete game: Players have a finite (called finite game) or
countably many (inifinite) number of strategies.
} Checking inequalities reaches a Nash equilibrium.

} Continuous game: Players have continuously many


strategies, e.g., choosing a real number (price or quantity)
from an interval.
} Infinitely many inequalities; cannot be checked one by one…
} Use deduction (Bertrand model) or differential approach
(Cournot model).

3 Lecture 4 2013 Winter


Bertrand Model
} Players: Two firms
} Strategies: Prices they will charge
} Payoffs: Profits

Assumptions:
} A linear demand function: P = a – bQ where b > 0
} Common marginal cost, c. (c < a)
} The firm with lower price must serve the entire
market demand.
} If the firms choose the same price, then each firm
sells the half of the market demand.
4 Lecture 4 2013 Winter
Nash Equilibrium
} There is a unique NE in which both firms charge the
price equal to their (common) marginal cost.

Why?
} Choosing different prices never becomes a NE.
} Choosing the same price other than the marginal
cost also fails to be a NE.
} If both firms choose p = c, then no firm has an (strict)
incentive to change the price.
⇒NE can also be solved by finding the intersection of
best response/reply curves.
5 Lecture 4 2013 Winter
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6 Lecture 4 2013 Winter
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Bertrand Paradox
} Even if there are only two competitors, prices will be set
at the level of marginal cost.
} In reality, there are many industries that look like the
Bertrand model but where prices are (much) higher than
marginal cost.
} There are at least three known explanations which can
reasonably resolve this paradox:
} Product differentiation
} Capacity constraints
} Dynamic interaction (collusion or cartel)

7 Lecture 4 2013 Winter


Cournot Model
} Players: Two firms
} Strategies: Quantities they will charge
} Payoffs: Profits

Assumptions:
} A linear demand function: P = a - bQ
} Common marginal cost, c.
} Firms cannot decide their prices to charge, but the
market price is determined so as to clear the market.
⇒ See Handout (“Oligopoly Competition” by Cabral).

8 Lecture 4 2013 Winter


Differential Approach
} Unlike Bertrand model, we CANNOT merely deduce an
equilibrium. Some calculation is necessary, instead.

} Under Nash equilibrium, each player takes a best


response against opponent’s strategy each other.
} Given other player’s strategy, each player maximizes her payoff
with respect to her own strategy.
} Can be solved by first order condition (which we call
differential approach).
} Nash equilibrium is just a solution of simultaneous equations
(of first order conditions).

9 Lecture 4 2013 Winter


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10 Lecture 4 2013 Winter
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Deriving Nash Equilibrium
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11 Lecture 4 2013 Winter


Best Response Curves (1) IA3)

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13 Lecture 4 2013 Winter


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Bertrand or Cournot?
} “Which model is the best?” or “Why do we need so
many models?”
} Both the Bertrand and Cournot models are particular
cases of a more general model of oligopoly competition
where firms choose prices and quantities (or capacities.)
} Bertrand: when firms can adjust capacities faster than
prices, e.g., software.
} Cournot: when prices can vary faster than capacities, e.g.,
wheat, cement.

14 Lecture 4 2013 Winter


Further Remarks
} The Bertrand and Cournot models are different
games, i.e., price competition vs. quality competition.
} The unique equilibrium concept (=NE) can explain
different market outcomes depending on the
situations (markets or industries).
} That is, we don’t need different assumptions about
firms’ behaviors.
⇒ Once a model is specified, then Nash equilibrium
gives us the result of the game.

15 Lecture 4 2013 Winter


Further Exercises
} Does iterated elimination of strictly dominated strategies
lead to the Nash equilibrium in the Cournot model?
} If yes, explain the process.
} In the spatial competition model, does the Nash
equilibrium change if each firm can choose location
continuously (i.e., a strategy is real number, not integer)?
} Consider the Bertrand model with asymmetric marginal
costs and derive the Nash equilibria.
} You can assume that the firm with lower marginal cost can take
all the market share if the firms charge the same price.

16 Lecture 4 2013 Winter

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