Managerial economics
Lec. 1 : Game theory and competition
1. What is managerial economics?
Managerial economics applies economic theory to managerial decisions:
Strategic behaviour of firms (industrial organization, innovation,
auctions)
Internal firm relations (information economics, bargaining)
Methods: game theory, optimization, discounting.
Managers face decisions about:
Pricing, forecasting, product positioning
R&D, patents, licensing
M&A, bargaining
HR and contract design
Market power is central: outside perfect competition, firms interact
strategically.
2. Game Theory fundamentals
2.1 What Is a game?
A game specifies:
Players
Actions/strategies
Payoffs (numerical representation of preferences)
Players are individually rational:
They have rational preferences.
They maximize their own payoff (not necessarily selfish).
, 2.2 Types of games
2.3 Strategic games
Characteristics:
Static: one-shot, simultaneous moves. ( no time)
Complete information: players know all payoffs and available
strategies.
Uncertainty allowed, but no asymmetric information.
2.4 Normal form
representation
A payoff matrix lists:
Rows = Player 1 actions
Columns = Player 2 actions
Each cell = (payoff P1, payoff P2)
, 3. Solving games
3.1 Dominated strategies
A strategy is strictly dominated if another strategy always gives a
higher payoff.
Example:
“Player 1’s strategy H is strictly dominated by D” (=all payoffs lower
of same player).
Remove H.
Then Player 2’s X strictly dominates Y and T.
Remaining strategies: (D, X) → equilibrium in dominant
strategies.
This process is
iterative
elimination of
dominated
strategies.
(+) If players are rational, it is the only possible outcome. Very reliable
prediction!
(-) too restrictive, most games don’t have one
3.2 Nash Equilibrium (NE)
Definition : A strategy profile where no player can increase their payoff
by unilaterally deviating.
Equivalent definition: Each player best-responds to the other’s
strategy.
Properties:
, Dominant-strategy equilibria are always Nash equilibria. (niet
andersom)
NE does not guarantee highest total
payoff.
NE may not be unique.
3.3 Finding NE via Best
Responses
Example (3×3 matrix):
Compute best responses for each player.
Intersection of best responses = NE.
In the example: (X, A) is the unique NE.
Quiz Dia 56
4. Demand, Monopoly & Competition
4.1 Market Demand
Graph in slides: downward-sloping demand curve.
Key concepts:
Slope:
Elasticity:
Elasticity determines revenue effects:
o |ε| < 1 → inelastic → raising price ↑ revenue
o |ε| > 1 → elastic → raising price ↓ revenu
Lec. 1 : Game theory and competition
1. What is managerial economics?
Managerial economics applies economic theory to managerial decisions:
Strategic behaviour of firms (industrial organization, innovation,
auctions)
Internal firm relations (information economics, bargaining)
Methods: game theory, optimization, discounting.
Managers face decisions about:
Pricing, forecasting, product positioning
R&D, patents, licensing
M&A, bargaining
HR and contract design
Market power is central: outside perfect competition, firms interact
strategically.
2. Game Theory fundamentals
2.1 What Is a game?
A game specifies:
Players
Actions/strategies
Payoffs (numerical representation of preferences)
Players are individually rational:
They have rational preferences.
They maximize their own payoff (not necessarily selfish).
, 2.2 Types of games
2.3 Strategic games
Characteristics:
Static: one-shot, simultaneous moves. ( no time)
Complete information: players know all payoffs and available
strategies.
Uncertainty allowed, but no asymmetric information.
2.4 Normal form
representation
A payoff matrix lists:
Rows = Player 1 actions
Columns = Player 2 actions
Each cell = (payoff P1, payoff P2)
, 3. Solving games
3.1 Dominated strategies
A strategy is strictly dominated if another strategy always gives a
higher payoff.
Example:
“Player 1’s strategy H is strictly dominated by D” (=all payoffs lower
of same player).
Remove H.
Then Player 2’s X strictly dominates Y and T.
Remaining strategies: (D, X) → equilibrium in dominant
strategies.
This process is
iterative
elimination of
dominated
strategies.
(+) If players are rational, it is the only possible outcome. Very reliable
prediction!
(-) too restrictive, most games don’t have one
3.2 Nash Equilibrium (NE)
Definition : A strategy profile where no player can increase their payoff
by unilaterally deviating.
Equivalent definition: Each player best-responds to the other’s
strategy.
Properties:
, Dominant-strategy equilibria are always Nash equilibria. (niet
andersom)
NE does not guarantee highest total
payoff.
NE may not be unique.
3.3 Finding NE via Best
Responses
Example (3×3 matrix):
Compute best responses for each player.
Intersection of best responses = NE.
In the example: (X, A) is the unique NE.
Quiz Dia 56
4. Demand, Monopoly & Competition
4.1 Market Demand
Graph in slides: downward-sloping demand curve.
Key concepts:
Slope:
Elasticity:
Elasticity determines revenue effects:
o |ε| < 1 → inelastic → raising price ↑ revenue
o |ε| > 1 → elastic → raising price ↓ revenu
