ECO 610-401 Monday, November 3 rd Game Theor y a nd Stra tegy: Repeat ed Games, Credi bilit y, a nd Collusion Readi ngs: Brick ley et . al , Ch apter 9:264 -273; Hoyt, Lecture 6 :13-19 Monday, November 10 th Incen tives and the Firm: An Intr oduc tion Incen tives and the Firm: Ince ntiv e Compe nsation Readi ngs: Brick ley et. al, Ch apter 2 :31-35; 1 0:280 -285; 15
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Are there advantages to being a leader?When and how can a firm maintain a leadership position?In this section we examine two forms of leadership and show how it is advantageous to
be a leader.In the next section we discuss how a leadership position can be maintained.In particular, to be a leader the firm must:
y Be able to credibly commit to a strategyy K now competitors' responsesy Punish competitors if they don't follow.
Is there an advantage in committing to production and sales goals first?Sta ckelburg model : Same as Cournot except 1 firm sets Q before the other firm.Result: The firm that moves 1st will have higher and output. This is because the
other firm knows that your Q cannot change and will cut his to keep price up.
1. Establish and use a reputation.2. Write contracts3. Cut off communication.4. Burn bridges behind you.5. L eave the outcome to chance.6. M ove in small steps.
7. D evelop Credibility through Teamwork.8. Employ M andated Negotiating Agents
I ssue 3: Does it matter how the monopoly arises or how itbehaves?
From Judge Hand s decision: It was an excuse, that Alcoa had not abused its power, it
lay upon Alcoa to prove it had not. But the whole issue isirrelevant anyway
The Act (Sherman Antitrust, 1914) had widerpurposes Many people believe that possession of unchallenged economic power deadens initiative,discourages thrigt and depresses energy; that immunityfrom competition is a narcotic and rivalry is a stimulant to
industrial progess Congress did not condone good trusts and condemn badtrusts ; it forbade all.
U.S. v. Alcoa, 3Issue 4: But did Alcoa actively attempt to monopolize and how?From Hand s opinion:
not a pound of ingot has been produced by anyone elsein the United States [T]his continued control did not fallundesigned into Alcoa s lap; obviously it could not have
done so. It was not inevitable that is should always anticipateincreases in the demand for ingot and be prepared to supplythem. Nothing compelled it to keep doubling and redoublingits capacity before others entered the field.
Facts: IBM dominated the rental market for mainframe C PU s for period
1964-1972 Also sold complete systems: C PU and periphals (terminals,
tapes, card readers) along with Burroughs and Honeywell Smaller firms (Telex) produced only peripheral equipment These smaller firms made significant inroads into IB M peripheralequipment (plug compatible) & charged much lower prices
The Bertrand equilibrium (price competition) with its competitive result might seem a bit dissatisfying--two firms giving a competitive result.
Suppose the game could be played repeatedly--would our results change?For example, suppose two firms start with agreeing to the monopoly price and a firm
considers cheating this month by cutting its price a small amount.Will it want to do so if it believes that next period its competitor will cut his price to c
y dis the discount rate and is equal to e -rt where r is the instantaneous rate of interest and t is thtime between periods. Essentially future profits, because of alternative uses of funds woul
be discounted.y Profits for each firm depend on both firms' prices and the firms are assumed to be in busines
T years.
y Will the firms want to collude for at least some of the time?y What will the attern of rices be over time?
The outcomes change when we consider games with infinite horizons.Suppose that both firms have the following strategy: charge the monopoly price, p m, in
period 0 and charge p m in period t if in every period preceding t its competitor charged p m; otherwise it sets its price at marginal cost, c, forever.
This strategy is referred to as a trigger strategy because a single deviation triggers a haltin cooperation.
Company town Implications:Upward-sloping supply curveWage < Marginal Factor Cost ( MFC)Why? Need to raise wage to induce more to work but need to do it for all workers
A Numerical Example:W*, the alternative wage, = $50,000Discount rate is 10%.P V of alternative wage is 95,450Net marginal productivity in the first period MP0 - Z = $40,000Net marginal productivity in the second period is $61,000.How will the worker be paid?2 conditionsP V of the earnings in the two period must equal $95,450.Earnings in period 2, W 1 > W* = $50,000 < MP1 = $61,000.If W0 = $45,000 and W 1=$55,500 all these conditions are satisfied.
How does compensation change if it is general ratherthan specific training?Worker has higher productivity in the firm paying for thetraining and elsewhere.Then: Either binding commitment for remaining in firm
following training Or, pay W
1= MP
1 what other firms will pay
If so, then W o = MPo Z in fact, worker pays fortraining.
Differences in wages due to differences in job conditionsare referred to as compensating wage differentialsFor individuals to be willing to take jobs with greaterrisks, everything else equal, they require greatercompensation
Men facing average fatal risk are paid compensation(relative to no risk) $166 to $277 a year (.53 to .89%)
Men facing average non-fatal risk are paid compensation(relative to no risk) $240 to $429 a year (.93 to 1.38%)Women facing average non-fatal risk are paidcompensation (relative to no risk) $714 to $1,119 a year (2.87 to 4.49%)