Outline
                                                                                                                                          • What is Industrial Economics?
                                                            Game Theory
                                                                     and                                                                  • Market Power
                                                     Industrial Economics
                                                                                                                                          • Main questions in Industrial Economics
                                                                                                                                          • Introduction to Game Theory
                                                                                                                                              A Taxonomy of Market Structures
                                               What is Industrial Economics?                                                                              Perfect Competition
                                                                                                                                                           • Many firms
                                                                                                                                                           • Free entry
                                                                                                                                                           • Homogeneous product
                                     •  The study of the operation and performance of                                                                      • No strategic interaction
                                        imperfectly competitive markets and the behaviour of                                          Monopolistic                                       Oligopoly
                                        firms in these markets                                                                         Competition                               • Few firms
                                                                                                                                    • Many firms                                 • Restricted entry
                                                                                                                                    • Free entry                                 • Homogeneous or differentiated
                                                                                                                                    • Differentiated product                       product
                                     •  What happens when perfect competition does not hold                                         • No strategic interaction                   • Strategic interaction
                                                                                                                                                                Monopoly
                                                                                                                                                           • 1 firm
                                                                                                                                                           • No free entry
                                                                                                                                                           • Homogeneous product
                                                                                                                                                           • No strategic interaction
                                                  Examples of Market Structures
                                                           Perfect Competition                                                        Main Questions of Industrial Economics
                                                            • Particular types of grains
                                                            • Particular types of milk
                                                                                                                                   1)     Is there Market Power?
                                        Monopolistic                                      Oligopoly
                                        Competition                               • Crude Oil (OPEC)                               2)     How is Market Power acquired & maintained?
                                     • Restaurants                                • Cars
                                     • Novels                                     • Breakfast Cereal                               3)     What are the implications of Market Power?
                                     • Cheese                                     • Sports shoes
                                     • Wine                                       • Computer Operating Systems
                                                                                                                                   4)     Is there a role for public policy regarding Market 
                                                                  Monopoly                                                                Power?
                                                             • Water supply
                                                             • Cable TV (per area)
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                                                                                                                                                           Game Theory
                                     •  Game theory:                                                                                Strategic Behaviour: Consider 2 firms, A and B.
                                        How to make decisions when there is strategic                                                   A’s optimal strategy is affected by B’s optimal strategy, 
                                        interaction                                                                                     and A takes this into account.
                                                                                                                                        B’s optimal strategy is affected by A’s optimal strategy, 
                                                                                                                                        and B takes this into account.
                                                               Game Theory                                                                                 Game Theory
                                  Strategic Behavior: Consider 2 firms, A and B.
                                      A’s optimal strategy is affected by B’s optimal strategy, and A takes this into                   Definition 1: A Game
                                      account.                                                                                           A game consists of:
                                      B’s optimal strategy is affected by A’s optimal strategy, and B takes this into 
                                      account.
                                                                                                                                              1) A set of players (assumed finite and countable).
                                      Furthermore:
                                      A’s optimal strategy takes into account the fact that B’s optimal strategy takes                        2) A set of strategies for each player.
                                      into account A’s optimal strategy.
                                      B’s optimal strategy takes into account the fact that A’s optimal strategy takes                        3) A pay-off function for each player.
                                      into account B’s optimal strategy.
                                      And so on successively…                                                                           Definition 2: Nash Equilibrium
                                      This creates an infinite loop. How do we break out of this problem?                               A set of strategies, one for each player, such that GIVEN the 
                                      John Nash’s insight…                                                                                  strategies of rivals no player can raise its payoff by deviating to 
                                                                                                                                            another strategy.
                                                                                                                                                     Simultaneous Choice Games
                                                              Types of games                                                                             A Cooperative Game
                                                                                                                                                               P2                     Possible Payoffs:
                                                       Simultaneous Choice Games                                                                         Confess  Quiet               • Jail: -1
                                                                                                                                                Confess (-1,-1)   (-2,+1)             • Free: 0
                                                                                                                                            P1                                        • Jail+Fine: -2
                                                       Sequential Move Games                                                                                                          • Free+Compensation: +1
                                                                                                                                                 Quiet   (+1,-2)   (0,0)
                                                                                                                                                                                      Strategies:
                                                       Repeated Games                                                                                                                 • Confess
                                                                                                                                                Payoffs:  (P1, P2)                    • Keep quiet
                                                       Dynamic Games                                                                Nash-Equilibrium:                                 Players:
                                                                                                                                             (Quiet, Quiet)
                                                                                                                                    Cooperative Outcome:                              P1, P2
                                                                                                                                             (Quiet, Quiet)
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                                          Simultaneous Choice Games Example: Duopoly                                                                       Sequential Move Games
                                             (Same Structure as the Prisoner’s Dilemma)
                                                                                     Firm 2                                                                      P1
                                                                            Competitive   Monopoly 
                                                                               Price        Price                                                      enter           not enter
                                                               Competitive     (0, 0)       (+4,-1)
                                                       Firm 1     Price                                                                                                  Π=0
                                                                Monopoly       (-1,+4)       (2, 2)                                                     P2               Π1=50
                                                                  Price                                                                                                    2
                                                                                                                                               fight          accept
                                                                  Payoffs:  (Firm 1, Firm 2)                                                   Π=-10          Π=10
                                                                                                                                                 1            Π1=20
                                      Nash-Equilibrium:                                                                                        Π2=-10           2
                                               (Competitive Price, Competitive Price)
                                                                                           Incentives to defect                  Nash-Equilibria:  (Fight, Not Enter), (Accept, Enter)
                                      Cooperative Outcome:
                                               (MonopolyPrice, MonopolyPrice)                                                    SubgamePerfectNash-Equilibrium:
                                                                                                                                                                                                         Build normal form
                                                           Sequential Move Games                                                                           Sequential Move Games
                                                 The importance of the sequence of moves                                                                          Stage Games
                                                                        P2
                                                             fight               accept                                                                Stage 1:                       Stage 2:
                                                                                                                                                   Players choose                 Players choose
                                                        P1                              P1                                                        long-run variable             short-run variable
                                               enter           not enter       enter          not enter
                                             Π1=-10            Π1=0         Π1=10             Π1=0
                                             Π2=-10            Π2=50        Π2=20             Π2=50
                                                                                                         Build normal form
                                                               Repeated Games                                                                         RepeatedPrisoner’s Dilemma
                                                                                                                                                                             Firm 2
                                                                                                                                                                    Competitive   Monopoly 
                                                                                                                                                                       Price        Price
                                                                                                                                                      Competitive      (0, 0)      (+4,-1)
                                                                                                                                              Firm 1      Price
                                                                                                                                                       Monopoly       (-1,+4)       (2, 2)
                                                                                                                                                          Price
                                                                                                                                                          Payoffs:  (Firm 1, Firm 2)
                                                                                                                                      Nash-Equilibrium:
                                                                                                                                               (Competitive Price, Competitive Price)
                                                                                                                                      Cooperative Outcome:
                                                                                                                                               (MonopolyPrice, MonopolyPrice)
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                                                                    Repeated Games:                                                                                     Game Theory Exercise
                                                         Sustaining Collusion/Cooperation                                                                                The Centipede Game
                                     Trigger Strategies: Play the cooperative strategy, as long as all other players play                                                                                                       100
                                          cooperatively (cooperative phase). Otherwise, play the competitive strategy for                         P1         P2         P1          …          P2         P1         P2
                                          the following T periods (punishment phase).                                                                                                                                           100
                                     Folk Theorem: If players are sufficiently patient (i.e., their discount rate is                               2          1          4                     95        98          97
                                          sufficiently low), any combination of payoffs can be sustained as an                                     0          3          2
                                                      *                                                                                                                                        97        96         101
                                          equilibrium , so long as players use trigger strategies.
                                                                                                                                                                               Π1
                                     * The equilibrium referred to here is a ‘Subgame Perfect Nash Equilibrium’                                                                Π2
                                                                   Suggested Reading
                                        •  Cabral (2000). Introduction to Industrial Organization, 
                                           MIT Press.
                                           Ch 1, 3, 4.
                                        •  Tirole (1988). The Theory of Industrial Organization, MIT 
                                           Press.
                                           Introduction and Appendix (Game Theory)
                                        •  Gibbons. A Primer in Game Theory.
                                        •  Reviews of I.O.
                                             – Schmalensee, R. Industrial organization. In New 
                                               Palgrave Dictionary of Economics
                                             – Schmalensee, R. Industrial organization: An overview. 
                                               Economic Journal 98, 643-681
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