Instructors Manual for Industrial Organization Theory and Applications by Oz Shy The MIT Press Cambridge, Massachusetts London, England Copyright c 19952004 Oz Shy. All rights reserved. The manual was typeset by the author using the L ATEX2 document preparation software by Leslie Lamport (a special version of Donald Knuths TEX program) during the months from September 1995 to November 1995 while I was visiting the Economics Department of the University of Michigan. All the gures are also drawn in L ATEX using software called TEXcad developed by Georg Horn, which can be downloaded from various mainframes. Version 1.0 Draft 20, (1995): Prepared for the rst printing of the rst edition bkman21.tex rst draft to be posted on the Web (2000/07/07) (parallel to the 5th Printing of the book) v.24 (2004/04/14): 6.1.d, 6.1.e This version: bkman24.tex2004/04/14 17:36 Contents To the Instructorv 2Basic Concepts in Noncooperative Game Theory1 3Technology, Production Cost, and Demand7 4Perfect Competition9 5The Monopoly11 6Markets for Homogeneous Products17 7Markets for Dierentiated Products25 8Concentration, Mergers, and Entry Barriers29 9Research and Development33 10The Economics of Compatibility and Standards35 11Advertising37 12Quality, Durability, and Warranties39 13Pricing Tactics: Two-Part Tari and Peak-Load Pricing43 14Marketing Tactics: Bundling, Upgrading, and Dealerships45 15Management, Compensation, and Regulation49 16Price Dispersion and Search Theory51 17Miscellaneous Industries53 To the Instructor Before planning the course, I urge the instructor to read carefully the Preface of the book that suggests dierent ways of organizing courses for dierent levels of students and also provides a list of calculus-free topics. The goals of this manual are: To provide the instructor with my solutions for all the problems listed at the end of each chapter; to convey to the instructor my views of what the important concepts in each topic are; to suggest which topics to choose for dierent types of classes and levels of students. Finally, please alert me to any errors or incorrect presentations that you detect in the book and in this manual. (e-mail addresses are given below). Note that the errata les (according to the printing sequence) are posted on the Web in PDF format. Before reporting errors and typos, please view the errata les to see whether the error you found was already identied and corrected. Haifa, Israel, (April 14, 2004) E-mail:ozshy Backup:OzBackup Web-page: Catalog-page:http:/mitpress.mit.edu/book-home.tcl?isbn=0262691795 This draft:bkman24.tex2004/04/14 17:36 Chapter 2 Basic Concepts in Noncooperative Game Theory An instructor of a short course should limit the discussion of game theory to the four most important concepts in this chapter that are essential for the understanding most of the analyses presented in this book: 1. The denition of a game (Denition 2.1): It is important that the student will understand that a game is not properly dened unless the list of players, the action set of each player, and the payo functions are clearly stated. It is important that the student will understand the meaning of the term outcome as a list of the specic actions chosen by each player (and not a list of payos as commonly assumed by students). 2. Nash equilibrium (Denition 2.4). 3. Welfare comparisons among outcomes (Denition 2.6). 4. Extensive form games, strategies (compare with actions), subgames, and the SPE (De- nition 2.10). I urge the instructor to discuss the issues of existence, uniqueness, and multiple equilibria in class. More precisely, it is important that the student will know that in order to prove existence, it is sucient to nd only one NE outcome; however, to prove nonexistence, the student must go over all outcomes and show that at least one player benets from unilateral deviation. I believe that the above can be covered in 2 lectures, or in three hours of instruction. If you wish to devote more time to game theory, you can introduce the equilibrium in dominant actions (Denition 2.3) before teaching the NE equilibrium concept. If you wish to emphasis more game theory, I advise covering repeated games (section 2.3). Answers to Exercises 1.(a) It is straightforward to conclude that R1(a2) = WARif a2=WAR WARif a2=PEACE and R2(a1) = WARif a1=WAR WARif a2=PEACE. That is, WAR is each players best response to each action taken by the other player (hence, WAR is a dominant action for each player). Now, ( a1, a2) = (WAR,WAR) is a (unique) NE since this outcome is on the best-response function of each player. (b) RJ(aR) = if aR= if aR= and RR(aJ) = if aJ= if aJ= . There does not exist a NE for this game since there does not exist an outcome the is on both best-response functions.That is, RJ() = , but RR() = , but RJ() = , but RR() = , so RJ() = , and so on. 2Basic Concepts in Noncooperative Game Theory (c) R(a) = Bif a= L Tif a