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ECON306: Industrial Organization

Unit 5: Models of Oligopoly   The behavior of firms in oligopoly continues to pique the interest of researchers, scholars, and students alike, who have generated numerous models to study the strategy of firms and their competitors in oligopolistic competition.  Please note that different models apply to different situations; in this regard, no one model can be deemed “better” than the other.  This section will introduce you to some of the first models of oligopoly that were built using the tools of noncooperative game theory.  The Cournot and Bertrand models presented here are known as static games of complete information, while the Stackelberg model belongs to the category of dynamic games.  Static and dynamic games are explained below.

A note on Game Theory: Game theory involves the process of strategic decision-making.   A game theoretic situation arises when the payoffs (profits) arising from the optimal choice made by a firm (or any agent) depends on the actions taken by others.  This is also called "payoff interdependency."   If the agent recognizes this interdependent decision-making, his optimal choice will be based on his expectations about the choices that others playing the "game” will make.  "Static games" are simultaneous move games in which each player moves once, not knowing the action of his or her rivals.  These games are sometimes also called "strategic games."   In a "dynamic game," players move sequentially with some knowledge of the actions taken by othersSuch games are often called "extensive games."

Both static and dynamic games can also be distinguished in terms of the level of certainty or uncertainty of rivals' actions.   With perfect information, all of the players know the entire history of the game when it is their turn to move, whereas in games of imperfect information, at least some of the players have only partial knowledge of the history of the game.   In games of complete information, everyone knows the payoffs that each player receives when the game is over.   However, in games of incomplete information, players know their own payoffs but may not know the ultimate payoffs of some of the other players.

Unit 5 Time Advisory
Time Advisory: This unit will take you 13 hours to complete.
·                     Subunit 5.1: 8 hours
·                  Subunit 5.1.1:1 hour
·                 Subunit 5.1.2:6 hours
·                 Subunit 5.1.3:1 hour
·        Subunit 5.2-5.4: 3 hours .
            Subunit:5.5: 2 hours

Unit5 Learning Outcomes
Upon successful completion of this unit, students will be able to:
•       Work with the fundamentals of game theory.  In general, explain the basic elements of a game, a classification of types of games, the role of equilibrium concepts, and the underlying assumptions of game-theoretic analysis.
·        Distinguish between game-theoretic situations and decision-theoretic situations.
·        Explain what is meant by non-cooperative game theory.
·        Differentiate between static and dynamic games.
·        Differentiate between games with perfect information and games with incomplete information.
·        Describe the fundamental assumptions on which game theoretic analysis is built.
·        Identify the questions or issues that are addressed by game theory.
·        Explain and identify a dominant strategy and its payoffs in a game.
·        Solve a "prisoner's dilemma" game.
·        Analyze the limitations of a prisoner's dilemma game.
·        Explain what is meant by a zero-sum game and solve the game using the "mixman" solution.
·        Define and solve games that  have mixed strategies.
·        Solve nonconstant sum games.
·        Define and be able to identify a Nash Equilibrium in games that have a unique or multiple Nash equilibria.
·        Solve games that have more than two players.
·        Explain cooperative games and solve them.
·        Explain and analyze sequential games and extensive-form games.
·        Solve games and find the sub-game perfect equilibrium.
·        Solve games like the Cournot-duopoly model.
·        Explain, solve, and analyze the Bertrand and the Stackelberg models.
·        Define and give examples of cartels.
·        Assess  how and why oligopolists collude amongst each other.
·        Define and analyze situations of non-cooperative and tacit collusions. 

5.1 Concepts in Game Theory   5.1.1 Introduction to Game Theory   - Reading: Berkeley Electronic Press: Jeffrey R. Church and Roger Ware's Industrial Organization: A Strategic Approach: "Chapter 7, Sections 7.1: Why Game Theory? and 7.2: Game-Theoretic Examples" Link: Berkeley Electronic Press: Jeffrey R. Church and Roger Ware's Industrial Organization: A Strategic Approach: "Chapter 7, Sections 7.1: Why Game Theory? and 7.2: Game-Theoretic Examples" (PDF)
 
Instructions: If you have not saved this PDF file, you will need to download the PDF file of the book by clicking on the "Download" tab on the right hand side of the webpage.  Please read the introduction along with sections 7.1 and 7.2 to familiarize yourself with some of the terms and concepts that are used in game theory.
 
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5.1.2 Static Games and Nash Equilibrium   - Reading: Static Games and Nash Equilibrium Link: Drexel University: Professor Roger McCain's Strategy and Conflict: An Introductory Sketch of Game Theory (HTML)
 
Instructions: Please read these webpages for intuitive explanations of some of the famous games in game theory.  For this section, please begin with the document titled "What Is Game Theory?" by clicking on the hyperlink of this title in the left side table of contents.  Proceed by clicking “next” at the bottom of each webpage you read until you reach the document titled "College Applicants." ."  Please skip the next two pages ("Proportional Games: The Commuter Game" and "Keynesian equilibrium as a Nash Equilibrium") and resume reading from "Cooperative Games," all the way up to "The Core and Competition."  After reading the material, it would be helpful for you to copy the games on a piece of paper and then try and solve them yourself.  This reading covers subunits 5.1.2.1-5.1.2.5.
 
Note on the Text: The pages in this website present a series of static games that you need to know at this level.  It progresses step-by-step through the games, explaining the problem of the game, how it is to be solved, and the related concepts associated with it. 
 
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5.1.2.1 The Prisoners' Dilemma   Note: This subunit is covered by the reading assigned under Unit 5.1.2. 

5.1.2.2 Zero-Sum Games   Note: This subunit is covered by the reading assigned under Unit 5.1.2. 

5.1.2.3 Non-constant Sum Games   Note: This subunit is covered by the reading assigned under Unit 5.1.2. 

5.1.2.4 Multiple Equilibria Games   Note: This subunit is covered by the reading assigned under Unit 5.1.2. 

5.1.2.5 Cooperative and Noncooperative Games   Note: This subunit is covered by the reading assigned under Unit 5.1.2. 

5.1.3 Dynamic Games and Nash Equilibrium   - Reading: Drexel University: Professor Roger McCain's Strategy and Conflict: An Introductory Sketch of Game Theory Link: Drexel University: Professor Roger McCain's Strategy and Conflict: An Introductory Sketch of Game Theory (HTML)
 
Instructions: Please read these pages for examples of sequential games along with their intuitive explanations.  For this section, please begin by clicking the hyperlink titled "Sequential Games" listed in the left side table of contents.  Proceed all the way to the last example titled "The Essence of Bankruptcy" by using the “next” button at the bottom of each webpage.  After reading the material, it would be helpful for you to copy the games on a piece of paper and then try and solve them yourself. 
 
Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

  • Reading: Berkeley Electronic Press: Jeffrey R. Church and Roger Ware's Industrial Organization: A Strategic Approach:"Chapter 9, Sections 9.1-9.4: Game Theory II" Link: Berkeley Electronic Press: Jeffrey R. Church and Roger Ware's Industrial Organization: A Strategic Approach: "Chapter 9, Sections 9.1-9.4: Game Theory II" (PDF)
     
    Instructions: If you have not saved this PDF file, you will need to download the PDF file of the book by clicking on the "Download" tab on the right hand side of the webpage.  Please read the introduction before reading sections 9.1 to 9.4.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

5.1.3.1 Extensive Forms   Note: This subunit is covered by the reading assigned under Unit 5.1.3

5.1.3.2 Strategies vs. Actions and Nash Equilibria   Note: This subunit is covered by the reading assigned under Unit 5.1.3

5.1.3.3 Subgame Perfect Nash Equilibrium   Note: This subunit is covered by the reading assigned under Unit 5.1.3

5.1.3.4 Two-Stage Games   Note: This subunit is covered by the reading assigned under Unit 5.1.3

5.2 Cournot Oligopoly (Homogenous Products)   - Reading: University of Toronto: Professor Martin J. Osborne's Theories of Oligopoly: “Strategic Games” and “Cournot’s Duopoly Model” Link: University of Toronto: Professor Martin J. Osborne's Theories of Oligopoly: “Strategic Games” (HTML) and “Cournot’s Duopoly Model” (HTML)
 
Instructions: Please click on each hyperlink above and read the webpages for each titled “Strategic Games” and “Cournot’s Duopoly Model” in their entirety.  The theoretical model presented in “Cournot’s Duopoly Model” will be clearer if you  click on the hyperlink titled "Examples and Exercises on Nash Equilibrium of Cournot's Model” (HTML) found before the section titled "Comparison with Competitive Equilibrium."  Also, on the “Cournot’s Duopoly Model” webpage proceed to the following link found at the bottom of the webpage: “Examples and Exercises on Comparisons of the Nash Equilibrium of Cournot's Model, the Competitive Output, and the Monopoly Output.” (HTML)
 
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  • Reading: Iowa State University: Arne Hallam's Econ 501: Microeconomics: “Oligopoly” Link: Iowa State University: Arne Hallam's Econ 501: Microeconomics: “Oligopoly” (PDF)
     
    Instructions: The above link will take you to the main page of the course Econ 501: Microeconomics.  Please click on “Oligopoly” under “Course Materials” to learn the three most important models of oligopoly.  Please skip sections 3.3 and 3.4, proceeding directly to section 4 (Bertrand Model) on page 18.  You may also skip sections 5 and 6, proceeding to section 7 (Stackelberg model) on page 28.  This reading covers units 5.2-5.3. 
     
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5.3 Bertrand Duopoly   Note: This subunit is covered by the reading assigned under Unit 5.2. 

5.4 Stackelberg (sequential) Oligopoly   5.5 Collusive Behavior   5.5.1 Cooperative Collusion-Cartels   - Reading: Clemson University: Professor Michael T. Maloney’s Econ 424: Industrial Organization: “Provisional Text and Lecture Notes” Link: Clemson University: Professor Michael T. Maloney’s Econ 424: Industrial Organization: “Provisional Text and Lecture Notes” (PDF)
 
Instructions: The above link will take you to the main page of Econ 424: Industrial Organization, taught by Professor Maloney.  Please click on the hyperlink titled "Provisional Text and Lecture Notes,” which will open up a PDF file.  Please read the topic titled "Cartels" on page 17 to learn more about how cartels operate and to see some examples of cartels in the US.
 
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  • Reading: University of Toronto: Professor Martin J. Osborne's “Collusion among Oligopolists” Link: University of Toronto: Professor Martin J. Osborne's “Collusion among Oligopolists” (HTML)
     
    Instructions: Please read the entire webpage linked above to learn how firms are affected in terms of profits, output, and price, if they decide to collude with each other.  At the bottom of the webpage, you will find "Examples and Exercises on Collusive Oligopoly." (HTML)  Please make sure to click on this hyperlink to see a numerical example of collusive behavior.
     
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5.5.2 Non-Cooperative Collusions   - Reading: The Saylor Foundation’s “Non-Cooperative Collusion and Tacit Collusion” Link: The Saylor Foundation’s "Non-Cooperative Collusion and Tacit Collusion" (PDF) and "Notes to Non-Cooperative Collusion and Tacit Collusion" (PDF)
 
Instructions: Please read the slides and the notes for slides 1-4 to learn about how firms make choices on whether to collude or not.  Note that this resource covers subunits 5.5.2 and 5.5.3.

5.5.3 Tacit Collusions   Note: This subunit is covered by the reading assigned under Unit 5.5.2.