This document discusses strategic pricing in oligopolistic markets. It explains that in these markets, firms are often afraid to change prices because they do not know how competitors will respond. If other firms follow a price change, demand becomes relatively inelastic. The document also discusses game theory concepts like the prisoner's dilemma and dominant strategies to analyze strategic decision-making between firms.

1. PRICING
STRATEGIC
AL
THINKING

2. Assume no cooperation or war among
firms
This model helps explain why the prices
in some oligopolistic markets change
very slowly over time
individual firms are often very afraid to
change price because of what other
firms might do.
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3. 3

4. 4

5. 5

6. 6

7. 7

8. On the other hand, if the other firms
do follow A’s price changes, then
there is going to be less substitution
taking place and the demand for A’s
product is going to be relatively
INELASTIC (steep slope).
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9. 9

10. What will you do if I lower price?
Follow and also lower price so
that I do not capture your
market share.
This makes my demand
INELASTIC (steep) below the
current price
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11.  When firms believe that their product is a
close substitute for their competitor’s
product, they do not have much incentive to
change price:
 A price decrease will be matched, so they
have nothing to gain by lowering price.
 A price increase will not be matched, so they
have a lot to lose by raising price.
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12. 12

13. 13

14. 14

15. 15

16.  Basic elements
 The players
 The strategies
 The payoffs
 Payoff matrix
 The fundamental tool of game theory.
 This is simply a way of organizing the potential
outcomes of a given game in a table that
describes the payoffs in a game for each possible
combination of strategies
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17. 17

18. 18

19. 19

20.  Duopoly situation – each of the two firms A and B
must decide whether to mount an expensive
advertising campaign.
 If each firm decides not to advertise, each will earn
a profit of £50,000.
 If one firm advertises and the other does not, the
firm that does will increase its profits by 50% to
£75,000, and drive the competition into a loss.
 If both firms advertise, they will earn £10,000 each
because the advertising expense forced by
competition wipes out large profits
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21.  If firms could agree to collude (FIX PRICES),
the optimal strategy would obviously be to
not advertise – maximize joint profits =
£100,000
 Let’s assume they cannot collude (FIX PRICES),
and therefore do not know what the competition
is doing.
 A “Dominant Strategy” is the one that is best no
matter what the opposition does.
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22. Firm B
Don’t Advertise Advertise
Don’t
Advertise
Firm A
Advertise
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A profit =
£50
B profit =
£50
A profit =
£75
B loss = £25
A profit =
£10
B profit =
£10
A loss = £25
B profit =
£75

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24. 24

25. 25

26. Me
Don’t Confess Confess
Don’t
Confess
B
Confess
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B= …
Me =…
B= Free
Me= … years
B = …years
Me= …years
B=…
me= Free

27. Prisoner’s Dilemma
 Each player has a dominant strategy
 It results in payoffs that are smaller than if
each had played a dominated strategy
Produces conflict between narrow self-
interest of individuals and the broader
interest of larger communities
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28. Why do people shout at
parties?
Why does everyone stand up
at concerts?
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29. A
Left Right
Top
B
Bottom
A’s behavior is predictable in this case.
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B profit =
100
A profit = 0
B loss = 100
A profit = 0
B profit =
200
A profit =
100
B profit =
100
A profit =
100

30. A
Left Right
Top
B
Bottom
Here, A’s behavior is again predictable – choose Right is the dominant
strategy – but now B stands to lose a great deal if by chance A chooses
left instead
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B profit =
100
A profit = 0
B loss =
10,000
A profit = 0
B profit =
200
A profit =
100
B profit =
100
A profit =
100

31.  Cartel
 A group of firms who sell a similar product who
have joined together in an agreement to act as a
monopoly – restrict output and raise price
 Normally cartels involve several firms
▪ Make retaliation against a dissenter difficult
 Agreements are not legally enforceable and are
hence inherently unstable
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32.  to reduce the uncertainty of a
noncooperative situation – competition over
market share makes firms unsure of what to
do with regard to pricing decisions – they’re
afraid to change prices – so to avoid the
possibility of a price war, firms might try to
cooperate.
 to increase profits – this need for profit can
turn out to be the downfall of most cartels –
GREED
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34. 34

35.  Where do the big profits come from at large state schools?
 sports
 Is it a competitive market?
 many schools… but the large profits suggest that there is some
monopoly power.
 The NCAA creates this market power and profit by restricting
output – limit the number of games per season, limit the
number of teams per division, strict eligibility guidelines for
schools…
 Up until 1984 the NCAA restricted the number of games on
TV and charged very high prices compared to today – but the
supreme court called it illegal collusion and as a result we
have much more games on TV today than 20 years ago.
 Can we say the same things can be said for professional
sports?
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36. 2 firms sell bottled water with MC = 0
The firms agree to act as a monopolist
and set price in order to maximize joint
profits (P*).
Each will produce ½ of the output.
No enforcement mechanism.
Cheating by 1 firm = selling the water at
< P* => that firm gains entire market.
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38. 38

39. Firms 1 & 2
Options: collude (price = £1.00) or
cheat (price = 0.90)
Is there a dominant strategy for
each firm?
Is there an incentive to cut prices
even more?
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40. Previously we assumed that players
moved at the same time
 However, timing is of the essence
Decision tree or game tree
 A diagram that
▪ Describes the possible moves in a game in
sequence
▪ Lists the payoffs that correspond to each
possible combination of moves
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41.  Assuming people are narrowly self-interested
does not always capture the full range of
motives
 Restaurants frequented mainly by out-of-towners
have the same tipping rates as those with mainly
repeat customers
 People care about being treated justly
 Sympathy for a trading partner can make a
business person trustworthy
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