hello and welcome back to our discussion on oligopoly uh we have looked at possible oligopoly
model where we have looked at the traditional marginal cost marginal revenue curves uh what
profit maximization would mean to a oligopolistic firm and we have looked at kinked demand curve
and then we went on to uh understand a little about game theory because we said that in
case of oligopoly it is more like a game for every individual firm where the firm has to
keep not only a constant watch on its own demand and cost but also a constant watch
on the uh price and quantity movements of its rivals uh
and that is the reason that it is more like a game where the oligopolistic firm has to
constantly uh make its own strategy or action plan to respond against different moves of
its uh rivals so we looked at the typical uh very traditional game of the prisoners
dilemma which uh which shows that why the 2 prisoners or why 2 individuals can uh settle
on a less than optimum uh uh situation because of self interest they are driven by self interest
and so the choices that they make ultimately put them in a situation where they are not
uh earning the maximum that they could have could have
so uh this we started with game theory lets uh take a few more examples and see what are
the situations how the situations can change is there any possibility that the firms could
actually uh stay put at a monopolistic situation is it possible for the firms to successfully
collude so we will see take a few examples and look at various possibilities .
so going back to our vodafone and airtel example uh we look at the example we relook at the
example as a game so now to quickly go through the example once more each firms objective
is to maximize profit they collude and decide to produce the monopolistic output together
and charge the monopoly price so each produces 30 units uh and gets a profit
of uh 900 rupees if one breaks the agreement and produces 40 he gets 1000 rupees and the
other gets 750 if both break the agreement each gets 800 rupees so what is each firms
dominant strategy and what is the nash equilibrium that is what we are interested in and uh lets
look at the same problem as a game and try to draw the payoff matrix for uh this example
.
so we have vodafone here and we have airtel here and what are the choices that they can
make so they have colluded and they have decided they know each of them knows that if they
stick to the monopoly price and if they stick to the monopoly quantity of 30 units each
that is the total output of 60 units in the market in that case each can earn a profit
of 900 rupees so one option for them is to stick to the
agreement and keep producing 30 units each so that is one of the options keep producing
30 units each now the other option is since price is now fixed each of the firms could
be tempted to produce a little more so if he produces a little more then he gets a bigger
share of the market and ends up getting a higher profit
so that is another choice say for example uh they can choose to produce 40 units each
so the other option is to produce 40 units each and then what is the what does the payoff
matrix look like then so uh if each of them produces 30 units then the payoff matrix has
profit of 900 for each firm if each of them ends up producing 40 units
both are producing 40 units so that the total output in the economy uh in the market goes
up to 80 units in that case profit drops to 800 and 800 each now if vodafone decides that
i am going to produce 40 units and airtel decides i am going to produce uh airtel continues
to produce 30 units in that case airtel is going to get a profit of 750 because now it
is producing less and vodafone is producing more and hence vodafone gets a profit of 1000
rupees and the opposite happens when airtel basically
defaults on the agreement and produce 40 units and vodafone sticks to the agreement and produces
30 units in that case airtel is going to get 1000 rupees and vodafone gets 750 so this
is what the payoff matrix actually looks like so if we try to think about the decision making
process of each of the firms in the framework of a game then the payoff matrix looks like
this so since this is the payoff matrix how do
they decide so vodafone decides that uh i have a choice either to produce 30 or 40 what
should i do if airtel has produced 30 so if airtel has produced 30 it makes sense for
me to produce 40 because in that case i will be getting a higher profit what happens if
airtel has produced 40 what happens if i cannot trust airtel and
airtel actually ends up producing more so what happens in that case what should i do
what should my strategy be so in case of (voda) so the vodafone now sees looks at the payoff
in both the cases and sees that if airtel produces 40 i will be worse off if i continue
to produce 30 and i should better be producing 40 so that i am at least i am at least getting
800 rupees which is same as what airtel is going to get
so in both the situations no matter what the decision of airtel is it makes sense for vodafone
to produce 40 units and same is the case for airtel hence 40 units is the dominant strategy
for each of the firms so each of the firms it makes sense to produce 40 units and so
this ends up becoming the nash equilibrium for both so this is the nash equilibrium for
both the firms so this is how we look at the decision making in the framework of a game
. uh lets uh move on to another example lets
take up another example where basically its a duopoly situation its a duopoly market with
only 2 major producers of aerated soft drinks that is we have the coke and the pepsi they
are the only ones who are supplying uh aerated soft drinks to this market and they have to
make a take a decision of whether to advertise or not
so we have already spoken a quite a lot about advertisement advertising the pros and cons
of advertising from the point of view of the firm also and we have seen that it is possible
for the firms to attract a larger amount of customers to themselves by just advertise
through just by advertising so its a kind of product differentiation a
notional differentiation that the firms are able to create in the minds of the customers
so now the but at the same time uh advertising can turn out to be really costly for the both
the firms so it is the decision that how much im going to gain by advertising because my
demand is going to go up against uh how much am i going to lose because my cost is also
going to go up because i will be spending so much money on advertising
so each of the firms knows that they would have been better off if none of them advertised
so if none of the firms advertise in a market then no one needs to spend anything so the
demand is basically uh continues to be the same for everyone so there is no possibility
of one firm uh poaching on the uh (consu) customers of other firms just to advertisement
so so this is the decision that the that the since there are only 2 firms in the industry
its one could imagine that the 2 firms would collude or cooperate and say that see its
costly for both of us so lets not advertise so lets see what happens so advertising can
shift individual demand curve of each of the firms to the right but advertising is costly
Firms may collude and decide not to advertise in which case each earns a profit of say 80
crore rupees each so lets assume that this is the amount they earn each of the firm is
earning if they are not advertising at all now if both decide to advertise they earn
a profit of rupees 30 crores each why has the profit gone down Because it is
costly for both the firms and since both the firms are advertising so the impact on demand
for both the firms is probably cancelling out and the net result is that both are incurring
higher cost without much increase in demand for both the firms now what happens if they
decide that lets advertise and then one firm basically breaks the agreement and uh goes
on to advertise in that case what is going to happen in the
market is although the the firm which is actually uh breaking the agreement his demand is going
to go up because he has advertised and the other firm has not advertised so he gets to
he successfully is able to attract a lot of customers of the other firm which is not advertising
so in that case since the other firms customer base falls that is his demand curve shrinks
and the demand curve of the firm that is advertising uh shifts to the right the firm the advertising
firm gets a high profit of say 30 crores while the firm which has not advertised he suffers
a loss of say uh 20 crores im sorry it is it wont be 30 it should be 130 because now
the profit is very high He its earning a high profit
so uh so these are the so if one breaks the so if one firm breaks the deal and advertises
and the other does not it earns a profit of 130 crores while the other suffers a loss
of 20 crores so what is the dominant strategy for each firm in this case so again let’s
look at the payoff matrix for each of the firms .
so we have pepsi here and say these are the 2 players and their options are to advertise
and no advertise again here coke also has similar options of advertise not advertise
so these are the options that they have and as per our payoff matrix so if they if both
advertises then each gets 30 30 they dont advertise then each gets 80 and 80
if pepsi does not advertise and coke advertises then coke gets a very high profit of 130 and
pepsi has a loss of pepsi incurs a loss of 20 crores so we denote it as minus 20 and
in case where pepsi advertises and coke does not advertise its just the opposite so it
is minus 20 for coke and 130 for pepsi so again so so it is uh now you probably know
uh you have probably understood the exercise how we are going to decide what is the dominant
strategy for both and we see that the dominant strategy for pepsi is to advertise because
when coke advertises pepsis payoff is more here in case of advertising when coke does
not advertise then also pepsis payoff uh cokes pepsis payoff is more in case of advertising
so advertising is the dominant strategy for pepsi and the same for coke also when pepsi
advertises cokes payoff is 30 and 30 and in case of not advertising it is uh sorry and
pepsi not advertising it is minus 20 so in case of pepsi also it is for coke also it
is advertising and in case of pepsi also it is advertising
so what they end up is this is the dominant strategy and this becomes their nash equilibrium
so this becomes their nash equilibrium so although had they stuck to the agreement of
not advertising each would be better off by getting a profit of 80 and 80 but since each
of them acts on their self-interest and each of them is uh not being able to trust the
other completely they end up in this box where they end up with a profit which is much lower
than the uh collusion situation where they successfully collude
so this is the example of cokes coke and pepsis decision now the question is does that mean
that cooperation is never possible Does that mean that cooperation is never possible because
had that been the case then probably we would not be having uh uh we would not be needing
a law to stop cartelization so cartels uh successfully sometimes run and
that is the reason that the competition law is always watchful of firms uh if they are
having any uh collusion and charging a monopoly price or quantity in the market so there is
a possibility of collusion and lets look at a few situations where cooperation may be
possible . now repeated games can enforce a cooperative
equilibrium How so so lets take the same example and look at what happens so lets go back to
the same example now what happens this is a one-time situation so this is a one-time
situation of pepsi and coke uh deciding or not deciding to advertise uh and then in this
situation this is the payoff that we are uh this is the equilibrium that we are reaching
now what happens uh if it is a repeated game which means that this is a decision or this
is a choice that pepsi and coke has to make every year say for example every year uh they
have to uh make this decision whether to uh launch a new advertisement new campaign or
not so this is a repeated game and uh in that case if it is a repeated game then what is
possible so in a repeated game now the pepsi and coke
both know that if i break the agreement in the following period if i break the agreement
my rival is also going to break the agreement so in that case i am worse off later so although
so let me let me give an example say for example pepsi and coke they uh say
for example pepsi tells coke that lets collude lets decide not to advertise but if you advertise
if you break the agreement then in the following all the periods i am going to advertise so
if this is a threat that one firm gives to the other in that case cooperation is possible
how so . so lets lets look at their payoffs now say
for example pepsi gives the threat and both decide that we are not going to advertise
so for pepsi and coke now pepsi has given coke this threat now coke if it decides that
if i break the agreement then in the first period im going to earn in the first period
im going to earn 130 crores and pepsi is going to make a loss of 20 crores in the following
periods so once pepsi suffers this loss pepsi is never ever going to not advertise
so pepsi is going to advertise in all the following periods because that is what pepsi
has threatened to do so in that case in all the following periods pepsi will be earning
a profit of 30 crores and coke will also have to earn a profit of 30 crores because then
it does not have any other because it knows that pepsi is going to advertise in the following
period so coke is also going to advertise in the following period and all the consequent
periods uh they are going to get a payoff of 30 each
so this is the situation when coke decides to break the agreement now what is the payoff
if coke does not break the agreement so this is where coke breaks the agreement so what
happens if coke does not break the agreement so let me write it here itself .
so when coke does not break the agreement in that case each earns 80 80 80 crores in
all the periods so in that case so in all the periods in all the periods both
are going to earn 80 each so obviously to coke this is a better situation than 130 so
this is a better situation than this this is a better situation than this because earning
130 in the first period and 30 in all the consecutive periods compared to earning 80
in all the periods is always uh so this is always a better choice for coke so coke is
going to stick to the agreement so this is where cooperation is possible and
why is cooperation possible here for pepsi this is a worse situation for pepsi this is
a worse situation because for pepsi it earns a loss in the first period so one thing that
needs to be kept in mind is the objective of the firm is to maximize its own profit
the objective of the firm is not to harm its uh harm its rivals or uh or not to create
a situation where the rival gets a uh earns a loss so that is not the objective of the
firm and since the objective of the firm is to maximize its own profit so none of the
firms is going to break the agreement so in case of repeated games repeated games can
enforce a cooperative equilibrium so even going back to the so this is although
this is a situation of threat where actually i said uh pepsi uh uh imposes a threat on
coke that i am going to um always break always advertise later uh but that is not always
necessary because sometimes the players learn through the game Say for example in the case
of prisoners dilemma it is possible if they are repeatedly getting caught and repeatedly
the same thing is happening probably they will learn over the overtime during the repetition
of the games that it is better not to talk so repeated games can enforce a cooperative
equilibrium now what is the difference if it is a finite
game so here i said it goes on till so they know that forever from now we are going to
earn this profit of uh where no one advertises but what happens if say for example in the
same situation where pepsi has given a threat that i am going to advertise in the later
periods and all of a sudden both of the firms come to know that in 10 years time the government
is going to pass a law that no one can advertise aerated uh soft drinks
the advertisement of or promotion of aerated uh soft drinks is banned so they know advertising
will be banned from on the 10th year Say note know that advertising will be banned on the
after the 10th year so till the 10th year from this is the 10th year and beyond that
advertising will be banned so in that case what are they going to do
so in that case uh pepsi just go to the situation of the 10th year now coke knows that in the
11th year pepsi cannot cannot exercise the threat because advertising will be banned
in any case so to the in the 10th year coke is going to break the agreement so coke is
going to break the agreement in the 10th year and pepsi also knows the same
pepsi knows that coke is going to break the agreement in the 10th year so pepsi is also
going to advertise in the 10th year now come uh come back a year earlier in the 9th year
pepsi coke pepsi knows that coke is going to break the agreement in the following year
so uh so and coke also knows that he is it is going to break the agreement in the following
year so they both advertise in the 9th year so this uh thinking or making or strategizing
in this way or planning in this way each of the firms come back a year earlier and they
they know that in the following period the the agreement will be broken and the knowledge
that the agreement will be broken at a later year basically breaks down the agreement in
the very first year so in the from the very first year itself
both are going to advertise and or this threat does not hold if there is a finite time for
which the threat is applicable so in that case both are going to advertise from the
very first period for the 10 years and after that in any case there is no advertising okay
another strategy is tit for tat strategy whatever one player does in one round the other player
does in the following round so this is also a situation where cooperation
is possible because the firm learns from the reaction of its rival so the year that it
has advertised following year the rival is going to advertise if it does not the other
also does the same so it knows that it can trust the other firm to do exactly the same
thing that it does in the first year so in that case cooperation is possible because
in that case cooperation in case of cooperation both of them are better off
so uh this was about game theory in the following module we are going to look at different ways
of pricing in case of a oligopoly firm thank you