Revision Session 28 th April 2015 Revision Session Office Hour Next Friday 8 th May 10301200 S1114 Main Themes of the Module Recap on Seminar Topics Past Exam Questions Main Themes of the Module ID: 406892
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Slide1
The Industrial Economy: Strategy
Revision Session – 28
th
April 2015Slide2
Revision Session
Office Hour: Next Friday 8
th
May 10:30-12:00 (S1.114)Main Themes of the ModuleRecap on Seminar TopicsPast Exam QuestionsSlide3
Main Themes of the Module
What is a firm and why do they exist?
Why do some firms succeed where others fail?
How do strategic considerations influence their behaviour?Much of the module (particularly the second half) used game theory to answer these questions.Slide4
Game Theory (1)
A ‘game’ is a model of
interactive
decision makingMultiple parties making strategic decisions
Specify:
Parties with decisions to make (Players)
Different choices available (Strategies)
Outcomes for each combination of choices (Payoffs)
Strategy A2
Strategy B2
Strategy
A1
*
,
*
*
,
*
Strategy B1
*
,
*
*
,
*Slide5
Game Theory (2)
In some games we can find strategies which are always
individually
optimal for the players (e.g. Prisoner’s Dilemma).
Confess
Stay Quiet
Confess
-5
,
-5
0
,
-10Stay Quiet-10 , 0-1 , -1
Dominant strategies are stable with respect to choice of other player
The strategy ‘Confess’ is always best. No matter
what the other player does: Dominant StrategySlide6
Game Theory (3)
Often there is no dominant strategy
W
e have to take a step back and instead look at stable outcomesConcept used: Nash Equilibrium
Outcome where every player plays a best response
(E.g. Chicken)
Swerve
Stick
Swerve
0
,
0-2 , 10Stick10 , -2
-20 , -20Slide7
Three Canonical Games Studied
Prisoner’s Dilemma Games
Application: Pricing, Cartels, Team Production
Coordination Games (Battle of the Sexes)Application: Industry StandardsAnti-Coordination Games (Chicken)Application: Patent Race, Quality GameSlide8
Seminar Topics (1)
Seminar 1:
Contracts
Why are they needed?
Types and pros/cons
(Anti)
Coordination
Problem
(Quality
Game)
What will happen?First mover advantageSeminar 2:InnovationFree rider problemDesign of patents(Anti) Coordination Problem(Raider Game)
How do we model this?What will happen?Slide9
Seminar Topics (2)
Seminar 3:
Cost of Capital
Wh
y is it important
?
Calculation
Product Differentiation
Outcome
of Bertrand
(Beach Restaurants
)Local monopolySeminar 4:Prisoner’s DilemmaApplicationsRepeated gameDuopoly Models
Bertrand assumptionsCournot modelSlide10
2010/2011 Exam – Q2Slide11
2010/2011 Exam – Q2 (a)
A
B
A
x
,
y
2
,
2
B
1 , 1y, xGeneral features of Battle of the Sexes:Players prefer to play the same strategy as the other playerNo dominant strategyTwo equilibria*In each equilibrium the person playing their ‘favourite’ strategy is better offNeed (A,A) and (B,B) to be equilibria, so adjust payoffs to make them soSlide12
2010/2011 Exam – Q2 (a)
A
B
A
x
,
y
2
,
2
B
1 , 1y, xNeed x>1 and y>2 (so P1 wishes to coordinate with P2)Need y>2 and x>1 But we also need that x>ySo, x=4 and y=3 will work!Slide13
2010/2011 Exam – Q2Slide14
2010/2011 Exam – Q2 (b)
A
B
A
4
,
3
2
,
2
B
1 , 13, 4This is a coordination game: No dominant strategyHard to tell what will happen if the game is played once!Players may try guess what the other will do and play the samePossibility of miscoordinationAny outcome feasibleLong run -> (A,A) or (B,B)Slide15
2010/2011 Exam – Q2Slide16
2010/2011 Exam – Q2 (c)
Division A
Division B
Division A
4
,
3
2
,
2
Division
B1 , 13, 4A firm has some free cash flow to allocate to either: Division A, Division B or ShareholdersManagers of A and B must lobby for resourcesIf managers do not agree then cash flow released as dividendManagers incentivised by division and company bonusesWould prefer to allocate resources to their own division but both prefer for it to stay within the firmOther example: Format wars (E.g. HD DVD v Blu
Ray)Slide17
2010/2011 Exam – Q2Slide18
2010/2011 Exam – Q2 (d)
How to solve the coordination problem:
Need some way to solidify expectations
ReputationSignalling / Communication
Convention
Commitment
A
B
A
4
,
3
2 , 2B1 , 13,
4Slide19
2009/2010 – Q5Slide20
2009/2010 - Q5 (a)
A
B
A
w
,
-4
3
,
x
B
-1 , y0, zGeneral features of Chicken:Player prefer to do the opposite of the others’ action No dominant strategyTwo equilibria*In each equilibrium the person playing A has higher payoffNeed (A,B) and (B,A) to be equilibria, so adjust payoffs to make them soSlide21
2009/2010 - Q5 (a)
Need w<-1 for player 1 (B is better if 2 plays A)
Need x
>-4 for player 2 (B is better if 1 plays A)Need y>z (A is better if 1 plays B)(Also know game is symmetric)
So, w=-4, x=-1, y=3 and z=0 will work!
A
B
A
w
,
-4
3
, xB-1 , y0, zSlide22
2009/2010 – Q5Slide23
2009/2010 - Q5
(b)
There is no dominant strategy
No strategy which is always bestIf this game were played once, anything can happenAny outcome can be rationalised e.g. (A,A)In the long run we would expect convergence to (A,B) or (B,A)
A
B
A
-4
,
-4
3
,
-1B-1 , 30, 0Slide24
2009/2010 – Q5Slide25
2009/2010 - Q5
(c)
Consider an innovation which is both ‘product’ & ‘process’
Innovation allows innovator to:Produce existing product more cheaplyProduce a new product which is a substitute to existing product
If one innovates and other does not -> innovator dominant
If both innovate they incur cost but do not differentiate
Other examples: Quality Game, Raider Game
Innovate
Hold Back
Innovate
-4
,
-43 , -1Hold Back-1 , 3
0, 0Slide26
2009/2010 – Q5Slide27
2009/2010
- Q5 (d)
How to solve the coordination problem:
Need some way to solidify expectationsReputation
Signalling / Communication
Convention
Commitment
A
B
A
-4
,
-43 , -1B-1 , 3
0, 0Slide28
2009/2010 – Q5Slide29
2009/2010
- Q5 (e)
Assume
Player 1 goes first:Whatever they pick, opponent will pick the oppositeOptimal for Player 1 to select A, forcing other to select B
Order of play tends to matter when there are multiple
equilibria
A
B
A
-4
,
-43 , -1B-1 , 3
0, 0Slide30
2010/2011 Exam – Q4Slide31
2010/2011 Exam – Q4
Quick discussion of Bertrand model
(2-3 paragraphs max)
Move on to Hotelling modelDescribe setting: Duopoly, differentiation along one aspect, no fixed cost, consumers care about ‘position’, fix firms ‘position’ and choose priceSlide32
Give an example and show P=MC is not an equilibrium
Find new equilibrium (if you have time):
D1 = Location of ‘Marginal Consumer’Write profit functionDifferentiate wrt price to get best responsesSolve for P1 and P2 (plug in to get profits)
2010/2011 Exam – Q4Slide33
What if:
Entry?
Sequential moves?
Position also variable?2010/2011 Exam – Q4Slide34
Final Advice
Get an overview of how the topics fit together (it will be difficult to study some parts and ignore others)
Become comfortable expressing points and examples in the form of diagrams and games
Make sure you clearly understand the techniques used in the seminars
Weigh up the pros and cons of different question types
Past exam questions
Look at Daniel’s advice in lectures 10 and 20