Managerial Decision Making and Market Structure Case Study

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Market Structure and Managerial Decision Making

The objective of this paper is to discuss the concept game theory in the competitive market environment where there are two or more firms competing against one another. The paper cites the examples of Nash equilibrium, prisoner dilemma, and dominant strategy. Moreover, the paper discusses the theory of perfect competition, monopoly, monopolistic market and theory of oligopoly. (Bhat, and Rau, 2008).

Game Theory

The game theory is a type of situation where the rewards or payoff given to any player depends on the action of the other players. The interdependence between two or more firms is referred as a game theory, and the rewards earned by a firm is known as a payoff, and the payoff matrix assists in analyzing the interdependence between firms. A duopoly is an interdependence between two players that may result in a game theory. However, a relationship between two players can lead to a concept of prisoner dilemma that occurs when the relationship between two or more firms affect each other's profits while at the same time they enter into an interdependence relationship. A prisoner dilemma is a particular type of game between two players where each player has an incentive to cheat other and derive benefits at the expense of another player. When both players cheat, both of them will be worse off than when neither of them cheats.

On the other hand, a concept of dominant strategy occurs when a player chooses the best action to satisfy his/her interest regardless of the order's player's course of action. However, a Nash equilibrium is a type of non-cooperative equilibrium where the action of each player is to maximize his payoff regardless of the other player course of action and ignoring the effect the action will have on other players. In the Nash equilibrium, a player does not consider the action of other players before taking action, and the prisoner dilemma occurs every day in the contemporary business environment.

The paper uses the business relationship between R.J. Reynolds and Phillips Morris to illustrate the concept of game theory, prisoner dilemma, dominant strategy, and Nash Equilibrium.

Case of R.J. Reynolds and Phillips Morris

"Philip Morris and R.J. Reynolds spend huge sums of money each year to advertise their tobacco products in an attempt to steal customers from each other. Suppose each year Philip Morris and R.J. Reynolds have to decide whether or not they want to spend money on advertising. If neither firm advertises, each will earn a profit of $2 million. If they both advertise, each will earn a profit of $1.5 million. If one firm advertises and the other does not, the firm that advertises will earn a profit of $2.8 million and the other firm will earn $1 million." (Krugman & Wells 2012, p 387).

The paper uses the payoff matrix to illustrate the relationship between R.J. Reynolds and Phillips Morris.

Fig 1: Payoff Matrix between R.J. Reynolds and Phillips Morris.

a)

b) If R.J. Reynolds and Phillips Morris enter into a duopoly to maximize profit, the best strategy to maximize their profits is for the two companies not to advertise as being revealed in the payoff matrix. If the two companies do not advertise, each of them will make $2 Million profit.

c). A dominant strategy may still occur between the two companies where each of the company intends to maximize their profit at the expense of another company. If each of the company chooses the dominant strategy, and Philip Morris and R.J Reynolds advertise, each will earn $1.5 million instead of $2 Million. However, if Philip Morris advertises and R.J. Reynolds does not advertise, Philip Morris will earn $2.8 Million profit while Reynolds will make $1 Million profit. However, if each firm advertises, each of them will earn $1.5 million profit. However, if one advertises and other company does not advertise, the company that advertises will earn $2.8 million while the second company that does not advertise will earn $1 Million. This type of relationship is a dominant strategy.

d)

The solution to the first question is not a Nash equilibrium. However, the solution to the second question is the example of Nash equilibrium because both Philip Morris and R.J Reynolds decide not to be cooperative in their relationship where one company advertises to increase their profits at the expense of another company.

Module 3 - Home

Under alternative market conditions, the goal of firms is to maximize profits. Moreover, firms are price takers and accept market prices introduced in the market.

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Moreover, both buyers and sellers are price takers under the alternative market conditions. The total output of a firm is very small compared to the output of the total market under alternative market conditions. Analysis of Prisoner's, Dominant Strategies and Nash Equilibrium

The prisoner's dilemma is the type of game theory where two prisoners are questioned over the innocence or guilt of a crime. However, the prisoner is either to confess or deny an involvement in the crime. The prisoner is a classic example of the traditional game theory where the prisoner is either to cooperate or betray the co-partner. However, the dominant strategy is a strategy where one player attempts to dominate other players. However, if both players use a dominate strategy, one player should use a unique Nash equilibrium. Moreover, betrayal is the dominant strategy in the prisoner dilemma. In the Nash equilibrium, both players intention is to betray one another, and cooperation in this type of game is difficult to achieve. In Nash equilibrium, the game theory is where participants pursue the best possible action against other players.

Pricing Strategy

A perfectly competitive market is a type of market where there are a large number of sellers and buyers. There is a large number of firms in the market, and no barrier to entering the market. Additional, the products sold on the market are identical, and all firms goal is to maximize their profits. In the store market, buyers are price takers because they accept the prices offered to them. (Townsend, 1995).Under a perfectly competitive market, the competitors accept a given market price where marginal revenue is equal to price MR=P. (Krugman, & Wells, 2012). Thus, the profit-maximizing condition is where marginal costs are equal to marginal revenue and equal to price (MC = MR = P) as being revealed in Fig 1.

Fig 1: Marginal Cost, Marginal Revenue, & Price

Monopolistic competition is a type of imperfect market competition where there are many producers sell differentiated products using quality and branding, however, the products are not perfect substitutes. Under the monopolistic competition, firms are price setters, and not price takers. (Mjmfoodie, 2011).

Under monopolistic competition, prices are above the MC (marginal cost) in the long run.

Monopoly

Under monopoly, there is only one firm in the market where firms are price setters rather than price takers. There is only one supplier in the market under a monopoly market. Typically, the goal of a monopoly is to develop a pricing strategy to maximize the profits. Being a sole supplier in the market, a monopoly set the price by setting a level of output to maximize profits.

Oligopoly is a market situation where there are few firms that sell differentiated or homogeneous products. In an oligopoly industry, few firms compete among one another. Thus, firms are likely to engage in price competition with oligopoly market. (Thomas, & Maurice 2008).

Theories of Industry Regulation.

The theory of regulation assumes that airlines, taxi services, trucking and farming industry should be regulated because these industries are highly competitive. For example, people controlling regulatory policy is to maximize political support. However, the aim of the antitrust law is to protect commerce and trade from monopolies, restraints, and price fixing. In the United States, most states pass their antitrust laws and oversee by the federal government. The DOJ (Department of Justice) is responsible for investigating the antitrust matter and indict a company that violates the law. Thus, a litigation can arise if a firm's operation is against the antitrust law.

Conclusion

In the competitive business environment, firms engage in a fierce competition to achieve market shares, and some firms use different strategies to dominate the market. The study uses the concept game theory to reveal the strategy firms employ to outperform other firms in the market. The study uses the theory of prisoner dilemma, Nash equilibrium, and dominant strategy to illustrate the concept game theory. The study also discusses the concept of perfect competition, monopolistic competition, monopoly, and oligopoly to reveal how firms fix prices under different market conditions.

Reference

Bhat, M.S., and Rau, A.V. (2008). Managerial Economics and Financial Analysis, Hyderabad, IND BS Publications, ProQuest ebrary. Web. Retrieved April 20, 2016, Chapter 4: Market Structures, pp. 85-107.

Krugman, P. & Wells, R. (2012). Economics and Microeconomics (Third Edition). Worth Publisher.

Mjmfoodie. (2011). Episode 29 Monopolistic Competition [Video File]. Retrieved from https://www.youtube.com/watch?v=T3F1Vt3IyNc

Links to Government Regulation of Monopoly

Thomas, C.R., and Maurice, S.C. (2008).Managerial Economics, McGraw-Hill. Power….....

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