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<title>Game theory</title></titleStmt>

<publicationStmt><distributor>BASE and Oxford Text Archive</distributor>


<availability><p>The British Academic Spoken English (BASE) corpus was developed at the

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(Department of Applied Linguistics, Reading), with funding from BALEAP,

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The recordings and transcriptions used in this study come from the British

Academic Spoken English (BASE) corpus, which was developed at the

Universities of Warwick and Reading under the directorship of Hilary Nesi

(Warwick) and Paul Thompson (Reading). Corpus development was assisted by

funding from the Universities of Warwick and Reading, BALEAP, EURALEX, the

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<person id="nm0763" role="main speaker" n="n" sex="m"><p>nm0763, main speaker, non-student, male</p></person>

<person id="sm0764" role="participant" n="s" sex="m"><p>sm0764, participant, student, male</p></person>

<personGrp id="ss" role="audience" size="m"><p>ss, audience, medium group </p></personGrp>

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<personGrp role="speakers" size="4"><p>number of speakers: 4</p></personGrp>





<item n="speechevent">Lecture</item>

<item n="acaddept">Economics</item>

<item n="acaddiv">ps</item>

<item n="partlevel">UG2</item>

<item n="module">unknown</item>




<u who="nm0763"> right well as you can see # <pause dur="0.2"/> i'm all <pause dur="0.2"/> wired up <pause dur="1.1"/><event desc="turns on overhead projector" iterated="n"/> for the benefit of # posterity <pause dur="0.9"/> # <pause dur="1.1"/> the <pause dur="0.2"/> synopsis of this lecture <pause dur="0.2"/> is in the handout <pause dur="0.3"/> that i gave out at two o'clock today <pause dur="1.0"/> and i'm going to be <pause dur="0.4"/> discussing the issue of <pause dur="0.5"/> sequential games <pause dur="0.5"/> # an aspect which in a way develops <pause dur="0.5"/> # quite nicely some of the issues that so far <pause dur="0.4"/> # have as it were cropped up <pause dur="0.5"/> # in the course of these lectures but have frankly <pause dur="0.3"/> # rather been fudged <pause dur="0.8"/><kinesic desc="puts on transparency" iterated="n"/> and the <pause dur="0.2"/> key <pause dur="0.3"/> # issue that we really fudged <pause dur="0.4"/> is exactly in what order <pause dur="0.5"/> # the moves are made <pause dur="0.3"/> within a particular game <pause dur="0.8"/> so what i now want to just review <pause dur="0.5"/> one or two basic concepts <pause dur="0.5"/> # that relate to <pause dur="0.6"/> representing games in a sense a more explicit form <pause dur="0.8"/> # this <pause dur="0.3"/> form is known as the extensive form of the game <pause dur="0.5"/> and it differs from the normal form <pause dur="0.3"/> bit of jargon this the normal form <pause dur="0.4"/> basically is the form of that matrix <pause dur="0.4"/> or bi-matrix that we've been working with in previous lectures <pause dur="0.3"/> we put up a table of rows and columns <pause dur="0.3"/> # we have a pair of numbers <pause dur="0.3"/> in each of the cells in the table <pause dur="0.3"/>

and that's how we represent the game <pause dur="0.8"/> we then proceed to analyse the game <pause dur="0.3"/> as if each player decided on their strategies <pause dur="0.4"/> independently <pause dur="0.3"/> of <pause dur="0.2"/> what the other <trunc>s</trunc> <pause dur="0.2"/> player decided <pause dur="0.6"/> but it's quite possible <pause dur="0.4"/> that in many cases a game could be played in such a way <pause dur="0.3"/> that one player moves first and the other moves second <pause dur="0.4"/> in which case the most important point would be <pause dur="0.4"/> that the player that moves second would know <pause dur="0.2"/> the decision <pause dur="0.4"/> that the first player had already made <pause dur="0.8"/> and there are then <pause dur="0.2"/> two possibilities here <pause dur="0.5"/> one is <pause dur="0.5"/> that because the second player <pause dur="0.5"/> is <pause dur="0.3"/> better informed <pause dur="0.4"/> than that is he knows what the first player's already decided <pause dur="0.4"/> whereas the first player when he made his move <pause dur="0.3"/> did not know what the second player was going to do <pause dur="0.4"/> that therefore this gives an advantage to the second player <pause dur="0.4"/> so you could say <pause dur="0.2"/> well the sequence will matter <pause dur="0.4"/> # because <pause dur="0.3"/> whoever moves second is in a stronger position <pause dur="0.4"/> because they have more information <pause dur="1.1"/> but actually there's another side to this <pause dur="0.8"/> and this depends on the following issue <pause dur="0.6"/>

and that is <pause dur="0.2"/> suppose that each of the players did know the other player's pay-offs <pause dur="0.8"/> you might be able to work out if you knew the other player's pay-offs <pause dur="0.3"/> what they would do under certain conditions <pause dur="0.3"/> given that they knew what you had done <pause dur="0.6"/> and therefore you might as it were have a degree of power <pause dur="0.5"/> because <pause dur="0.2"/> by moving first you could frame <pause dur="0.5"/> the context in which the second decision was made <pause dur="0.6"/> and if you knew the other player's pay-offs <pause dur="0.3"/> you could then <pause dur="0.2"/> work out before you made your move <pause dur="0.4"/> how the other player would respond <pause dur="0.5"/> so it's by no means clear when players do make moves <pause dur="0.4"/> whether the <pause dur="0.2"/> advantage lies with the first mover <pause dur="0.4"/> or with the second mover <pause dur="0.4"/> it all depends to some degree <pause dur="0.2"/> on the nature of the game the structure of the pay-offs on the one hand <pause dur="0.5"/> and how much the players know <pause dur="0.3"/> before the game starts <pause dur="0.3"/> about each other's pay-offs and that <pause dur="0.3"/> brings me to the second point <pause dur="0.4"/> about the <pause dur="0.3"/> information set <pause dur="0.5"/> because <pause dur="0.2"/> the information set is basically what each player knows <pause dur="0.6"/> and <pause dur="0.3"/> # in a game

played out sequentially <pause dur="0.4"/> the information set changes because as the moves are made <pause dur="0.4"/> new information <pause dur="0.3"/> on what moves have been made <pause dur="0.3"/> is added to the information set <pause dur="0.5"/> and what this means is <pause dur="0.7"/> that the <pause dur="1.0"/> information set changes <pause dur="0.4"/> as the game proceeds <pause dur="0.8"/> now <pause dur="0.2"/> in one sense that then makes the whole analysis much more <pause dur="0.3"/> complicated <pause dur="0.5"/> but <pause dur="0.4"/> in another sense <pause dur="0.3"/> it it actually makes it in some respect simpler too <pause dur="0.5"/> the reason that it makes it in some sense simpler is this <pause dur="0.6"/> that if there is a a final stage of the game <pause dur="0.6"/> then you can imagine <pause dur="0.3"/> what the players would be doing at this final stage of the game <pause dur="0.6"/> if there were a definite last play <pause dur="0.6"/> # a last step in the game <pause dur="0.5"/> then <pause dur="0.2"/> both the players would presumably know <pause dur="0.3"/> everything that had happened up to that stage <pause dur="0.6"/> and you could then construct a series of scenarios <pause dur="0.4"/> if a certain sequence of moves had occurred <pause dur="0.3"/> and the players knew this <pause dur="0.3"/> in the final step <pause dur="0.4"/> they would <pause dur="0.2"/> be equipped with the following information and would <pause dur="0.2"/> behave in the following way <pause dur="0.7"/> so <pause dur="0.4"/> you can construct

a range of scenarios to work out in principle <pause dur="0.3"/> how the various players would move at the final stage of the game <pause dur="0.5"/> depending on what had gone before <pause dur="0.7"/> and then if the players themselves <pause dur="0.5"/> could work out what was likely to happen at later plays <pause dur="0.4"/> they could make their own <pause dur="0.2"/> earlier plays in the knowledge of what the consequences of those plays would be <pause dur="0.4"/> for later stages of the game <pause dur="0.5"/> and that is basically what is meant by the concept firstly of backward induction <pause dur="0.4"/> that is to solve games that are in a sequential form <pause dur="0.3"/> what one does is begin with the final stage and work backwards <pause dur="0.4"/> towards deciding what each player will do at the outset <pause dur="1.0"/> and the allied concept of <pause dur="0.3"/> subgame perfection <pause dur="0.6"/> is that at any stage in a game <pause dur="0.5"/> each player will look ahead <pause dur="0.6"/> at all the scenarios that could develop <pause dur="0.4"/> as a result of alternative decisions by they might make at that stage <pause dur="0.6"/> and therefore subgame perfection basically means <pause dur="0.3"/> that each player <pause dur="0.3"/> # works <pause dur="0.3"/> # with full use of the information they have at any stage <pause dur="0.3"/> as to what

the repercussions <pause dur="0.4"/> of that move might be <pause dur="0.6"/> in the context for example of a game of chess <pause dur="0.3"/> # <pause dur="0.2"/> a chess player <pause dur="0.3"/> who is operating with backward induction and subgame perfection <pause dur="0.4"/> basically tries to identify <pause dur="0.3"/> all the possible endgames that might <pause dur="0.2"/> develop <pause dur="0.7"/> and then works back to decide which of these endgames he would like to get into <pause dur="0.7"/> and therefore finally arrives at the question <pause dur="0.3"/> if i make this move what endgame am i likely to finish up with <pause dur="0.4"/> if i make that move what endgame am i likely to finish up with <pause dur="0.4"/> and therefore solves the game in that way <pause dur="0.4"/> now chess is a notoriously complex game <pause dur="0.4"/> and one of the <pause dur="0.2"/> # attractive features of it <pause dur="0.2"/> is that it's in fact not normally difficult for people <pause dur="0.3"/> with finite human <pause dur="0.3"/> # rationality <pause dur="0.3"/> to actually approach a game of chess in that way <pause dur="0.4"/> but with the <pause dur="0.2"/> simpler games certainly two by two games of the kind that we've been discussing in this course <pause dur="0.5"/> it is possible to approach them in this way <pause dur="0.3"/> and i will in fact illustrate <pause dur="0.3"/> # how that can be done <pause dur="1.3"/> and # <pause dur="0.2"/> finally this

analysis of <pause dur="0.3"/> sequential <pause dur="0.3"/> games also provides a discussion <pause dur="0.5"/> of issues relating to <pause dur="0.4"/> credibility <pause dur="0.7"/> and credibility is an important issue in modern economics <pause dur="0.4"/> for example we're told that <pause dur="0.2"/> the independence <pause dur="0.2"/> of the Bank of England <pause dur="0.3"/> gives <pause dur="0.2"/> credibility <pause dur="0.3"/> to monetary policy <pause dur="0.9"/> we're told <pause dur="0.3"/> that # <pause dur="0.8"/> for countries that enter in to treaties <pause dur="0.3"/> through the World Trade Organization <pause dur="0.5"/> give credibility to their competition and trade policies <pause dur="0.4"/> because if they were to change them at some future time <pause dur="0.4"/> they would suffer severe penalties and everybody knows this <pause dur="0.9"/> we also discuss in industrial economics <pause dur="0.4"/> issues about whether <pause dur="0.3"/> particular <pause dur="0.3"/> strategies towards entry deterrents are credible <pause dur="0.7"/> if a firm in an industry <pause dur="0.4"/> says to a potential entrant <pause dur="0.7"/> if you enter <pause dur="0.5"/> i will cut price and that will put you out of business <pause dur="0.6"/> is that threat actually a credible threat which will <pause dur="0.7"/> keep out the entrant <pause dur="0.6"/> or is it a not credible threat <pause dur="0.3"/> because if the entrant were to actually enter <pause dur="0.4"/> they would call the incumbent firm's bluff <pause dur="0.5"/> then the

incumbent would then be faced with the situation well given <pause dur="0.2"/> that they've entered <pause dur="0.4"/> that we all know they've entered <pause dur="0.5"/> it's no longer <pause dur="0.3"/> # rational for me to carry out my threat <pause dur="0.6"/> so by looking ahead at later stages of the game <pause dur="0.6"/> one can investigate <pause dur="0.3"/> what kind of promises commitments <pause dur="0.2"/> threats and so on <pause dur="0.3"/> can economic agents make to one another <pause dur="0.5"/> and <pause dur="0.3"/> which of them will be discounted <pause dur="0.5"/> as being not credible I-E <pause dur="0.3"/> not rational in the light of <pause dur="0.3"/> what will later materialize <pause dur="0.3"/> and which of them can be identified <pause dur="0.3"/> <kinesic desc="changes transparency" iterated="y" dur="2"/> as being # rational <pause dur="0.6"/> so let's start on this <pause dur="0.3"/> # by going back <pause dur="0.2"/> to # a very simple issue <pause dur="0.3"/> of some games we've already looked at <pause dur="1.0"/> the first game we've looked at <pause dur="0.4"/> is the prisoner's dilemma <pause dur="0.6"/> and in the prisoner's dilemma as you will i hope recall <pause dur="0.4"/> # the strategy of cheating <pause dur="0.4"/> in a one shot game is always dominant <pause dur="0.5"/> now what that means is <pause dur="0.4"/> that if you say to one player <pause dur="0.3"/> okay you go first <pause dur="0.3"/> the other player will then go after <pause dur="1.0"/> neither player <pause dur="0.5"/> minds what the other player is going to do because

whatever the other player does <pause dur="0.8"/> whatever the other player does it always pays them to cheat <pause dur="0.5"/> so the prisoner's dilemma is a special type of game <pause dur="0.4"/> in which the sequence of moves <pause dur="0.2"/> doesn't actually matter <pause dur="0.5"/> because each player has a dominant strategy whatever the other player does <pause dur="0.6"/> they do the same thing <pause dur="0.4"/> so knowing what the other player's going to do <pause dur="0.3"/> doesn't alter <pause dur="0.2"/> the way they will act at all <pause dur="0.7"/> but there are other games we've looked at <pause dur="0.3"/> <kinesic desc="changes transparency" iterated="y" dur="2"/> where the sequence does matter <pause dur="0.5"/> and the simplest example of this <pause dur="0.4"/> is the battle of the sexes game <pause dur="0.5"/> where we have Jack and Jill <pause dur="0.4"/> # going either to the wrestling or to the opera <pause dur="0.7"/> and we have two possible <pause dur="0.3"/> scenarios that we can distinguish here <pause dur="0.6"/> in the first Jack <pause dur="0.3"/> makes the decision <pause dur="0.5"/> announces what he's going to do and leaves Jill to respond <pause dur="0.5"/> and in the second Jill moves first <pause dur="0.7"/> now the essence of this as i say <pause dur="0.3"/> is based on the idea <pause dur="0.5"/> that <pause dur="0.2"/> each player <pause dur="0.2"/> may have a knowledge of the other player's pay-offs <pause dur="0.5"/> so let's suppose in this case <pause dur="0.4"/> that Jack knows not only Jack's

preferences but also Jill's preferences <pause dur="0.5"/> and that Jill knows not only Jill's preferences <pause dur="0.4"/> but also Jack's preferences <pause dur="1.1"/> suppose now we # <pause dur="0.3"/> look at the game and represent it in this <pause dur="0.3"/> # what's called the extensive form <pause dur="0.4"/> the extensive form is usually portrayed <pause dur="0.3"/> in the form of decision trees <pause dur="0.4"/> so if we look at this first decision tree <pause dur="0.4"/> what this says is we start up here <pause dur="0.8"/><kinesic desc="indicates point on transparency" iterated="n"/> and the first person <pause dur="0.4"/> to move to make a decision <pause dur="0.3"/> is Jack and Jack makes a decision <pause dur="0.3"/> either to go wrestling <pause dur="0.4"/> or to go to the opera <pause dur="1.1"/> that decision then becomes known it's obviously known to Jack because he made it <pause dur="0.3"/> but it also becomes known to Jill <pause dur="0.5"/> and when that decision's made <pause dur="0.3"/> then Jill <pause dur="0.4"/> # can decide whether to go wrestling or go to the opera <pause dur="1.0"/> but under these circumstances <pause dur="0.7"/> if <pause dur="0.5"/> Jack <pause dur="0.2"/> knows <pause dur="1.5"/> that # <pause dur="0.9"/> Jill <pause dur="0.3"/> is <pause dur="0.6"/> # aware of his decision <pause dur="1.0"/> then he can calculate what Jill will do <pause dur="0.6"/> because he can say if i go wrestling <pause dur="0.9"/> then given her pay-offs <pause dur="0.5"/> Jill will want to go wrestling too because although she doesn't much like the wrestling <pause dur="0.4"/> she'd rather <trunc>g</trunc> be same place i am <pause dur="0.4"/> rather than somewhere completely different <pause dur="0.9"/> so if i go wrestling <pause dur="0.5"/> then <pause dur="0.8"/> Jill will go wrestling too <pause dur="0.9"/> on the other hand if i go to the opera <pause dur="0.9"/> Jill will also go to the opera she likes going to the opera <pause dur="0.4"/> but she'll go there <pause dur="0.2"/> just to meet me how nice <pause dur="0.7"/>

so <pause dur="0.2"/> in that case <pause dur="0.2"/> Jack knowing Jill's preferences <pause dur="0.4"/> knows <pause dur="0.4"/> that whatever he does <pause dur="0.4"/> it will pay Jill once she knows what he's done <pause dur="0.4"/> to do the same <pause dur="0.6"/> but he can then use this information to his own advantage <pause dur="0.7"/> because by moving first he can say aha <pause dur="0.8"/> i can go wrestling <pause dur="0.6"/> because i know that even though Jill would rather go to the opera <pause dur="0.7"/> if she knows i am going to the wrestling she'll go to the wrestling too <pause dur="0.5"/> so as long as he makes sure that Jill knows the decision <pause dur="0.5"/> the ability to move first <pause dur="0.4"/> means that he can go to the wrestling <pause dur="0.6"/> # and then Jill goes to the wrestling and he's better off <pause dur="0.9"/> he gets a pay-off of two <pause dur="0.6"/> whereas if <pause dur="0.3"/> he'd gone to the opera <pause dur="0.3"/> he could predict that Jill would go to the opera <pause dur="0.3"/> but he would only get a pay-off of one <pause dur="0.8"/> so here is an example of first mover advantage <pause dur="0.3"/> the advantage here is that <pause dur="0.3"/> although Jill is better informed <pause dur="0.7"/> Jack can anticipate Jill's responses to his actions <pause dur="0.4"/> and therefore he can as it were endogenize Jill's response to his action <pause dur="0.5"/> # in in deciding what he

will do <pause dur="1.7"/> and if Jill moves first instead <pause dur="0.3"/> then we get a different result <pause dur="0.8"/> because now if Jill <pause dur="0.4"/> can work out <pause dur="0.7"/> how Jack will behave <pause dur="0.2"/> from her knowledge of <pause dur="0.6"/> his preferences <pause dur="0.9"/> then the situation is as follows <pause dur="0.6"/> Jill moves first and if she goes to the wrestling <pause dur="0.4"/> she can predict that Jack will go to the wrestling because <pause dur="0.3"/> he likes to meet her and he likes wrestling <pause dur="0.9"/> but if she goes to the opera <pause dur="0.4"/> Jack will go to the opera because although he doesn't much like opera <pause dur="0.4"/> he'd rather go there <pause dur="0.2"/> than miss meeting her all together <pause dur="0.7"/> so Jill knows that if she goes to the opera Jack will go to the opera provided he knows she's gone to the opera <pause dur="0.6"/> and she <pause dur="0.3"/> will then <pause dur="0.3"/> # get <pause dur="0.4"/> a pay-off of two <pause dur="0.3"/> whereas if she goes wrestling Jack will go wrestling <pause dur="0.4"/> and she will only get a pay-off of one <pause dur="0.6"/> so <pause dur="0.3"/> Jill will then go to the opera <pause dur="0.6"/> so the decision is different <pause dur="0.5"/> according to the sequence <pause dur="0.3"/> in which the game is played <pause dur="0.8"/> so sequence does in fact matter <pause dur="0.7"/> now <pause dur="0.5"/> the only difficulty with this <pause dur="0.4"/> is that it imposes a sequence in

which one does go first <pause dur="0.4"/> and the other <pause dur="0.3"/> then knows about it <pause dur="0.6"/> this <pause dur="0.7"/> extensive form representation <pause dur="0.4"/> would be a good deal more useful <pause dur="0.4"/> if it also contained the previous kind of game <pause dur="0.4"/> where the two players didn't know what each other had done <pause dur="0.4"/> # within it as well <pause dur="0.4"/> and so what people have done <pause dur="0.4"/> is to <pause dur="0.3"/> take this sequential <kinesic desc="changes transparency" iterated="y" dur="3"/> # approach <pause dur="0.3"/> but to introduce a particular <pause dur="0.3"/> refinement of it <pause dur="0.5"/> which is to group together <pause dur="0.7"/> particular <pause dur="0.6"/> # nodes in the decision tree <pause dur="0.5"/> where people in fact do not have the information <pause dur="0.4"/> about the decision that has been made <pause dur="1.2"/> so if we wanted to portray <pause dur="0.5"/> simultaneous moves <pause dur="1.8"/> that is moves where neither party knows the other <pause dur="0.4"/> what we can do <pause dur="0.3"/> is suppose <pause dur="0.4"/> that they actually take place in sequence <pause dur="0.4"/> but that the first decision is not known <pause dur="0.7"/> to the person who acts later <pause dur="0.8"/> so we <pause dur="0.2"/> allow a temporal sequence <pause dur="0.4"/> but we allow a veil of ignorance to surround <pause dur="0.3"/> the initial move <pause dur="0.6"/> and that veil of ignorance is illustrated by drawing this line <pause dur="0.3"/> round these two points <pause dur="0.3"/> implying <pause dur="0.2"/> that Jill cannot

distinguish between them <pause dur="0.6"/> in other words Jack's moved first he's made his decision <pause dur="0.4"/> Jack knows what he's done <pause dur="0.5"/> but Jill doesn't <pause dur="0.7"/> under these circumstances we're back to the previous <pause dur="0.4"/> # indeterminacy <pause dur="0.4"/> # in the outcome we're back to the previous situation of multiple outcomes <pause dur="0.4"/> because <pause dur="0.8"/> if Jack moves first but <pause dur="0.2"/> but Jill won't know what he's decided <pause dur="0.8"/> then Jack <pause dur="0.3"/> can't really infer exactly what Jill will do <pause dur="0.3"/> unless he has a theory <pause dur="0.5"/> about what beliefs Jill forms in the absence of any information <pause dur="0.4"/> on what he has done and that takes us straight back to the probability <pause dur="0.5"/> calculations <pause dur="0.3"/> that we've been using in the previous lectures <pause dur="0.7"/> but the point is this <pause dur="0.3"/> with the aid of this <pause dur="0.3"/> # device <pause dur="0.3"/> we can now represent any game involving simultaneous moves <pause dur="0.5"/> as a game involving sequential moves <pause dur="0.4"/> and therefore this extensive form of the game <pause dur="0.3"/> which portrays games in the form of decision trees <pause dur="0.3"/> is indeed more general <pause dur="0.5"/> and <pause dur="0.2"/> where we are dealing with truly sequential moves <pause dur="0.3"/><event desc="takes off transparency" iterated="n"/> it's much more advantageous <pause dur="0.5"/> # than the <pause dur="0.3"/> # alternative

approach <pause dur="0.7"/> what i now what to do is simply give an example <pause dur="0.4"/> of a sequential game <pause dur="0.4"/> and link it in <pause dur="0.3"/> to the point that i made <pause dur="0.4"/> about <pause dur="0.2"/> the credibility <pause dur="0.5"/> # <pause dur="0.3"/> of commitments and and and threats <pause dur="0.3"/> within the context of a sequential game <pause dur="0.5"/> i am going to take this game because it's a microcourse <pause dur="0.4"/> from <pause dur="0.2"/> microtheory <pause dur="0.4"/> and we're <kinesic desc="puts on transparency" iterated="n"/> going to look at a standard issue <pause dur="0.4"/> in industrial organization <pause dur="0.5"/> # an entry game <pause dur="1.1"/> and <pause dur="0.3"/> what i'm going to do is i'm first going to look at the game <pause dur="0.4"/> in the ordinary normal form that we've used before <pause dur="0.5"/> and see how far you could get <pause dur="0.3"/> using that ordinary <pause dur="0.3"/> normal form <pause dur="0.3"/> and the equilibrium concepts that we've been employing up till now <pause dur="0.8"/> i'll then argue <pause dur="0.4"/> that this game is inherently sequential <pause dur="0.7"/> and that to represent it as if the moves were simultaneous <pause dur="0.5"/> # is really quite misleading <pause dur="0.4"/> and that a good deal of additional insight <pause dur="0.3"/> into what actually goes on in these situations <pause dur="0.4"/> # can be obtained <pause dur="0.4"/> if you switch <pause dur="0.3"/> # to using the extensive form <pause dur="0.3"/> which allows for people to make their moves in their natural

sequence <pause dur="0.9"/> so <pause dur="0.8"/> let's portray the game in the following way <pause dur="0.4"/> the entrant has a choice of two strategies <pause dur="0.3"/> one of which is simply not to enter <pause dur="0.3"/> the other of which is to enter <pause dur="1.4"/> the incumbent <pause dur="0.5"/> # has a choice of strategies <pause dur="0.3"/> if entry occurs <pause dur="0.7"/> that is he can either <pause dur="0.4"/> acquiesce in the entry <pause dur="0.9"/> or he can fight it <pause dur="0.7"/> if he acquiesces <pause dur="0.3"/> then basically he accepts that the <pause dur="0.4"/> market power that he had before <pause dur="0.5"/> is to some extent diminished by a rival <pause dur="1.8"/> or alternatively <pause dur="0.4"/> he can <pause dur="0.4"/> fight <pause dur="0.7"/> and fight basically means precipitate a price war <pause dur="0.5"/> with a view to damaging <pause dur="0.4"/> the rival's <pause dur="0.2"/> <trunc>th</trunc> <trunc>d</trunc> <trunc>dama</trunc> damaging the entrant's profitability <pause dur="1.8"/> so <pause dur="0.8"/> i've got here a structure of pay-offs what does this structure of pay-offs symbolize well firstly <pause dur="0.6"/> if the entrant stays out <pause dur="0.6"/> the entrant is the row player <pause dur="0.3"/> so their numbers are the first in these pairs <pause dur="0.6"/> if the entrant stays out then he gets no profits i mean that's just <pause dur="0.2"/> a a a null strategy <pause dur="0.5"/> so there's nothing for the entrant if he stays out <pause dur="0.4"/> so far as the incumbent is concerned <pause dur="0.4"/> he retains his

dominant position in the market <pause dur="0.4"/> and so he gets a handsome return <pause dur="0.4"/> of <pause dur="0.2"/> thirteen units <pause dur="0.5"/> so that's just fine <pause dur="0.3"/> for the <pause dur="0.3"/> # incumbent firm <pause dur="0.7"/> if the entrant enters <pause dur="0.7"/> then the incumbent can acquiesce <pause dur="0.5"/> that means that the incumbent <pause dur="0.3"/> simply switches if he was a monopolist <pause dur="0.5"/> to <pause dur="0.3"/> some form of duopolistic behaviour <pause dur="0.6"/> so perhaps instead of having strong monopoly power <pause dur="0.4"/> there's now some degree <pause dur="0.5"/> of tacit <pause dur="0.5"/> duopolistic collusion <pause dur="0.4"/> the result is that the <pause dur="0.4"/> two firms <pause dur="0.3"/> share a rather diminished profit <pause dur="0.6"/> they share a diminished profit a total profit of six <pause dur="0.4"/> as opposed previously to the profit of thirteen <pause dur="0.4"/> that the incumbent had all for themselves <pause dur="1.4"/> alternatively <pause dur="0.4"/> the <trunc>e</trunc> incumbent can fight <pause dur="0.4"/> and if the incumbent fights then basically he drops the price very dramatically <pause dur="0.4"/> saying to the incumbent basically there's no way you are getting a foothold in this market <pause dur="0.4"/> unless you're prepared to buy market share <pause dur="0.4"/> at a loss-making price <pause dur="0.6"/> as a result of which he can inflict a loss <pause dur="0.4"/> of five <pause dur="0.4"/> on the entrant <pause dur="0.3"/> but only at the expense of

inflicting a loss <pause dur="0.3"/> of five <pause dur="0.3"/> on himself <pause dur="1.2"/> now <pause dur="0.4"/> if we just look at this in its present form <pause dur="0.6"/> # as a two by two game <pause dur="0.5"/> # with sequential moves <pause dur="0.4"/> then <pause dur="0.2"/> we would proceed to calculate the equilibria <pause dur="0.4"/> # in the usual way i'm only interested here <pause dur="0.3"/> in pure strategy equilibria <pause dur="0.4"/> so we can do that quite simply in terms of best responses <pause dur="0.8"/> # and we can suppose to begin with <pause dur="0.3"/> that the entrant stays out <pause dur="0.7"/> # if the entrant stays out <pause dur="0.3"/> then the incumbent <pause dur="0.7"/> doesn't have to do anything <pause dur="0.5"/> so it doesn't really matter whether he acquiesces or fights <pause dur="0.9"/> # either is a response because nothing has happened <pause dur="0.5"/> so <pause dur="0.4"/> both of these are underlined they're both possible responses <pause dur="0.4"/> to the entrant staying out <pause dur="0.4"/> that's a weakness of the normal form <pause dur="0.3"/> it doesn't really capture the fact <pause dur="0.3"/> that these strategies only really come into being <pause dur="0.3"/> if the entrant really does enter <pause dur="0.5"/> but technically <pause dur="0.4"/> both of these are best responses to the <pause dur="0.4"/> # entrant's play out strategy <pause dur="0.8"/> so far as the incumbent is concerned if the entrant enters <pause dur="0.4"/> this is quite important <pause dur="0.4"/> it pays to acquiesce <pause dur="0.3"/> because three <pause dur="0.4"/> is <pause dur="0.2"/> better than minus-five <pause dur="0.6"/> so <pause dur="0.2"/> if <pause dur="0.3"/> the entrant were to enter <pause dur="0.5"/> and the incumbent <pause dur="0.3"/> # knew that he had <pause dur="0.5"/> then <pause dur="0.2"/> the incumbent would <pause dur="0.4"/> acquiesce <pause dur="1.5"/>

so far as the entrant is concerned <pause dur="0.4"/> if he thinks <pause dur="0.4"/> the incumbent will acquiesce <pause dur="0.5"/> then he'll enter <pause dur="0.7"/> because if he stays out he gets zero but if he enters and the incumbent acquiesces he gets three <pause dur="0.8"/> so if he thinks <pause dur="0.5"/> that the <pause dur="0.8"/> incumbent will acquiesce then entry will occur <pause dur="1.3"/> alternatively if he thinks that the incumbent will <pause dur="0.2"/> fight <pause dur="0.7"/> then it's better to stay out <pause dur="0.4"/> because he will get zero if he stays out but incur a loss <pause dur="0.4"/> of five if he goes in <pause dur="0.7"/> and so if we now just look at where the equilibria are <pause dur="0.5"/> we see that there are two equilibria <pause dur="0.4"/> in one of which entry <pause dur="0.5"/> # <pause dur="0.4"/> is combined with acquiescence <pause dur="0.8"/> and <pause dur="0.2"/> the other is that the entrant stays out <pause dur="0.3"/> because in some senses <pause dur="0.4"/> the <pause dur="0.4"/> the table suggests <pause dur="0.3"/> that the <pause dur="0.3"/> entrant <pause dur="0.2"/> that that the incumbent will be prepared <pause dur="0.4"/> to fight <pause dur="0.8"/> now that discussion <pause dur="0.3"/> isn't is partly adequate it's partly adequate because it does capture one insight <pause dur="0.4"/> it captures the insight that <pause dur="0.4"/> if the entrant were to enter <pause dur="0.4"/> it would pay the incumbent to acquiesce which is an important result <pause dur="0.8"/> but it's also <pause dur="0.3"/> #

a bit unsatisfactory <pause dur="0.5"/> and it's unsatisfactory <pause dur="0.3"/> because the method of analysis we're using <pause dur="0.3"/> suggests <pause dur="0.4"/> that as it were <pause dur="0.3"/> the moves are simultaneous <pause dur="0.4"/> but in fact <pause dur="0.4"/> when you think the situation through <pause dur="0.4"/> this is inherently a sequential game <pause dur="0.5"/> because inherently what happens is <pause dur="0.4"/> that the entrant makes a decision <pause dur="0.7"/> and then the incumbent can decide <pause dur="0.4"/> the incumbent can decide what to do <pause dur="0.4"/> once he knows <pause dur="0.2"/> whether or not entry has occurred <pause dur="0.5"/> that is to say <pause dur="0.2"/> there's no reason <pause dur="0.4"/> for <pause dur="0.3"/> # <pause dur="0.5"/> the incumbent to start fighting an entrant who hasn't actually appeared <pause dur="0.8"/> so <pause dur="0.3"/> really <pause dur="0.3"/> # what we need to do is to move <pause dur="0.4"/> to the <kinesic desc="changes transparency" iterated="y" dur="1"/> sequential <pause dur="0.2"/> form <pause dur="0.4"/> in order to get a more realistic picture <pause dur="0.6"/> what this sequential form does <pause dur="0.3"/> is it recognizes <pause dur="0.4"/> that the entrant does indeed move first <pause dur="1.1"/> and the incumbent then moves second <pause dur="0.6"/> and the incumbent only has a choice <pause dur="0.4"/> if the entrant enters <pause dur="0.4"/> so so this representation based on the extensive form <pause dur="0.4"/> with its decision tree <pause dur="0.5"/> says <pause dur="0.2"/> okay the entrant makes the first decision <pause dur="0.4"/> the entrant stays out there's nothing

more to be said <pause dur="0.7"/> the # incumbent firm retains its market power <pause dur="0.4"/> the entrant gets nothing <pause dur="0.5"/> but if <pause dur="0.2"/> the entrant enters <pause dur="0.3"/> then the incumbent has the choice <pause dur="0.4"/> and that's where the pay-offs come in <pause dur="0.3"/> he can then either acquiesce or he can fight <pause dur="1.3"/> now <pause dur="0.3"/> how will this game then be played <pause dur="0.4"/> given <pause dur="0.5"/> that the sequence of moves is in this way <pause dur="0.8"/> well <pause dur="1.2"/> if <pause dur="0.7"/> we invoke the assumption that both players know the other player's pay-offs as well as their own <pause dur="0.9"/> then the entrant can calculate <pause dur="0.4"/> what the incumbent will do <pause dur="0.9"/> because <pause dur="0.4"/> the <pause dur="0.3"/> entrant knows <pause dur="0.4"/> these pay-offs he knows both <pause dur="0.7"/> all the numbers <pause dur="0.9"/> so he can say well right once i enter <pause dur="1.2"/> once i've entered the incumbent knows i've entered <pause dur="0.6"/> and if he acquiesces he gets three <pause dur="0.7"/> and if he fights he gets minus-five <pause dur="0.2"/> so once i've entered <pause dur="1.5"/> he will acquiesce <pause dur="0.2"/> i know that <pause dur="0.4"/> he will acquiesce <pause dur="0.5"/> suppose then that the incumbent <pause dur="0.8"/> says to the entrant if you enter i will fight <pause dur="1.0"/> what does the <pause dur="0.9"/> entrant do just discounts it one-hundred per cent it's just cheap talk <pause dur="0.6"/> it means nothing why because <pause dur="0.5"/> the

entrant knows the incumbent's pay-offs <pause dur="0.4"/> and knows that although the entrant would like him to believe <pause dur="0.5"/> that he would fight <pause dur="0.8"/> the threat is not credible <pause dur="0.4"/> because once the entrant has entered and the incumbent knows it <pause dur="0.3"/> it won't pay him to implement his threat <pause dur="0.3"/> it'd be stupid of him to implement his threat <pause dur="0.3"/> only if there were further plays <pause dur="0.4"/> in which reputation effects became important <pause dur="0.3"/> might the incumbent wish to implement the threat <pause dur="0.3"/> for the sake of what might happen in some subsequent entry context <pause dur="0.4"/> but if we ignore <pause dur="0.4"/> the the repetition of the game <pause dur="0.4"/> then basically <pause dur="0.5"/> the incumbent's threat <pause dur="0.3"/> has no credibility <pause dur="0.5"/> the incumbent's threat has no credibility <pause dur="0.3"/> because it's not in line with the structure of pay-offs <pause dur="0.3"/> that the entrant knows <pause dur="0.7"/> so what does the entrant do <pause dur="0.6"/> well the entrant knows that if he enters <pause dur="0.5"/> the incumbent will acquiesce and therefore he'll get a pay-off of three <pause dur="0.7"/> whereas if he stays out he will get a pay-off of zero <pause dur="0.6"/> so he enters <pause dur="0.7"/> so in fact we have a unique

equilibrium <pause dur="0.4"/> we had <pause dur="0.2"/> # multiple equilibria <pause dur="0.3"/> in that rather unsatisfactory analysis based on the normal form <pause dur="0.3"/> once we introduce the sequential structure explicitly <pause dur="0.4"/> we move to a plausible <pause dur="0.3"/> and unique equilibrium <pause dur="0.4"/> of entry <pause dur="0.3"/> followed by acquiescence <pause dur="1.8"/> <event desc="takes off transparency" iterated="n"/> the question then <pause dur="0.4"/> arises <pause dur="0.7"/> as well is there anything that the incumbent can do <pause dur="0.4"/> about this <pause dur="1.0"/> i mean we've seen that the incumbent can't just make threats <pause dur="0.8"/> because they won't <trunc>believ</trunc> be believable <pause dur="0.5"/> under these conditions <pause dur="0.4"/> is there anything the incumbent could do <pause dur="0.8"/> well people who've studied these situations have argued yes there are certain things <pause dur="0.4"/> the incumbent can do <pause dur="0.8"/> and basically <pause dur="0.4"/> # <pause dur="0.3"/> the kind of thing that the incumbent can do <pause dur="0.7"/> is to say well look <pause dur="0.5"/> part of the problem in the story i've just told <pause dur="0.7"/> is that the entrant gets to make the first move <pause dur="0.3"/> and therefore frames <pause dur="0.7"/> the decision that i then have to make and he knows that <pause dur="0.4"/> that that he can frame my decision <pause dur="0.7"/> suppose that i as incumbent <pause dur="0.4"/> could do something could could <pause dur="0.2"/> i could make the first move

before any entrant appears <pause dur="0.5"/> could i do something <pause dur="0.4"/> before the entrant appears <pause dur="1.0"/> in such a way that when an entrant looks at the situation <pause dur="0.7"/> they'll say oh dear i don't want to enter <pause dur="0.5"/> because under the conditions the incumbent has set up <pause dur="0.3"/> it will pay him to fight <pause dur="0.4"/> is there something the incumbent can do while he's incumbent before the entrant appears <pause dur="0.5"/> that <trunc>w</trunc> can be <pause dur="0.2"/> set up to give credibility <pause dur="0.4"/> to threats that they <pause dur="0.3"/> lacked under the present situation <pause dur="0.9"/> well <pause dur="0.3"/> we can make one or two observations <pause dur="0.3"/> one thing is this <pause dur="0.9"/> that that if the incumbent is going to do this thing at the outset <pause dur="0.8"/> it should ideally be irreversible <pause dur="0.8"/> because if for example the incumbent does something <pause dur="1.2"/> but <pause dur="0.4"/> if the entrant enters <pause dur="0.5"/> it just pays the incumbent to undo it <pause dur="0.9"/> then of course it's as if it'd never been done <pause dur="0.4"/> so it's got to be something that the incumbent does at the outset <pause dur="0.5"/> the entrant comes in <pause dur="0.4"/> but <pause dur="0.7"/> the <pause dur="0.3"/> the <pause dur="0.4"/> the incumbent can't then simply say <pause dur="0.5"/> ah well forget that i'll go back to what i was doing before <pause dur="0.3"/> because the

entrant would know that <pause dur="0.3"/> and would know then that the circumstances would revert <pause dur="0.4"/> to the original ones <pause dur="0.4"/> so the incumbent if he's going to deter the entrant has to do something <pause dur="0.4"/> and do something in a clearly irreversible fashion <pause dur="0.4"/> what's the most irreversible thing most people can do in an industry <pause dur="0.4"/> is invest <pause dur="0.5"/> invest in highly specific <pause dur="0.3"/><kinesic desc="puts on transparency" iterated="n"/> capacity <pause dur="0.8"/> capacity that has no use <pause dur="0.3"/> outside the industry <pause dur="0.5"/> so what you do <pause dur="0.3"/> is you build a plant <pause dur="1.8"/> and you build it in such a way <pause dur="0.3"/> that its scrap value <pause dur="0.4"/> or its value in producing any alternative product <pause dur="0.4"/> is <pause dur="0.3"/> virtually zero <pause dur="0.7"/>

so that means that once you've built this plant <pause dur="0.3"/> you might as well operate it <pause dur="0.5"/> now under what conditions would that work <pause dur="0.5"/> that would work under conditions really <pause dur="0.3"/> in which <pause dur="0.2"/> firstly the equipment itself <pause dur="0.3"/> is very rigid not flexible <pause dur="0.6"/> specific not versatile <pause dur="0.6"/> but secondly why you would want it in the first place <pause dur="0.7"/> one reason why you might want it is that although it costs you a lot of money to buy it <pause dur="0.4"/> it brings down the marginal cost of production <pause dur="0.4"/> to a very low level <pause dur="0.8"/> because what this means is that by investing in this very specific equipment <pause dur="0.4"/> that will reduce variable costs <pause dur="0.3"/> by incurring large sunk costs <pause dur="0.4"/> it means that once you've put that <pause dur="0.4"/> spent that money <pause dur="0.4"/> you can't get it back <pause dur="0.3"/> you're simply left with very very low variable costs <pause dur="0.6"/> and this would mean that you could profitably fight a price war <pause dur="1.1"/> so <pause dur="0.3"/> an entrant therefore confronted <pause dur="0.4"/> with an incumbent that has made a very large <pause dur="0.4"/> irrecoverable investment <pause dur="0.3"/> in an asset <pause dur="0.2"/> that will reduce the marginal costs of

production <pause dur="0.4"/> knows that if they enter <pause dur="0.3"/> they face an entrant who has an economic incentive <pause dur="0.4"/> very probably <pause dur="0.4"/> to actually fight a price war even if <pause dur="0.5"/> entry did occur <pause dur="0.4"/> and that's what this <pause dur="0.2"/> # example shows <pause dur="0.4"/> # <pause dur="0.2"/> i don't want to go through all the <pause dur="0.3"/> # precise # <pause dur="1.2"/> numerical details of it <pause dur="0.4"/> but suffice it to say that what we imagine <pause dur="0.3"/> going on here <pause dur="0.6"/> is that <pause dur="0.4"/> the <pause dur="0.3"/> incumbent <pause dur="0.4"/> sinks <pause dur="0.4"/> # nine units of cost <pause dur="1.4"/> into <pause dur="0.5"/> # <pause dur="0.2"/> a <pause dur="0.5"/> specific <pause dur="0.5"/> # <pause dur="0.2"/> <trunc>i</trunc> <trunc>i</trunc> <trunc>i</trunc> <trunc>i</trunc> into a specific piece of equipment <pause dur="1.0"/> and what this specific piece of equipment allows the entrant <pause dur="0.3"/> <trunc>th</trunc> allows the incumbent to do <pause dur="0.4"/> is to <pause dur="0.2"/> fight a price war <pause dur="0.5"/> without making <pause dur="0.4"/> # <pause dur="0.5"/> any # losses <pause dur="0.9"/> and <pause dur="0.3"/> if you then <pause dur="0.4"/> # study the pattern of pay-offs <pause dur="0.5"/> # what you find is <pause dur="0.5"/> that the modification of the pay-offs <pause dur="0.4"/> effected <pause dur="0.4"/> by the <pause dur="0.3"/> investment in the <pause dur="0.3"/> # specific piece of capital equipment <pause dur="0.4"/> means that the entrant's best response <pause dur="0.4"/> to <pause dur="0.5"/> entry the incumbent's best response to entry <pause dur="0.4"/> is to fight <pause dur="1.5"/> that then translates into the fact that the entrant <pause dur="0.2"/> who has the full information available <pause dur="0.4"/> knows that the incumbent now <pause dur="0.4"/> faces

a situation where the best response to entry <pause dur="0.7"/> is to fight <pause dur="1.5"/> now <pause dur="0.5"/> also <pause dur="0.7"/> the <pause dur="0.4"/> incumbent <pause dur="0.3"/> knows that <pause dur="0.2"/> the entrant will know that he has invested in the equipment <pause dur="1.0"/> and so <pause dur="0.6"/> the <pause dur="0.4"/> incumbent knows that if he buys the equipment <pause dur="0.4"/> the entrant <pause dur="0.3"/> looking at the consequences of entry <pause dur="0.4"/> will see that the consequences of entry will be a fight <pause dur="1.1"/> and therefore <pause dur="0.7"/> the implication of this is <pause dur="0.4"/> that if <pause dur="0.3"/> the incumbent invests <pause dur="0.3"/> the entrant will be deterred from entry <pause dur="0.5"/> because if the entrant tries to enter <pause dur="0.3"/> he will incur losses <pause dur="0.4"/> because it will pay <pause dur="0.2"/> the incumbent to fight <pause dur="1.0"/> on the other hand <pause dur="0.5"/> if the incumbent doesn't invest <pause dur="1.1"/> then he knows that he's back with the game we just discussed <pause dur="0.7"/> back with the game where <pause dur="0.3"/> the entrant will not <pause dur="1.1"/> stay out but will enter <pause dur="0.5"/> and where it will then pay him to acquiesce <pause dur="0.7"/> so what he has to do <pause dur="0.4"/> as the incumbent <pause dur="0.6"/> # is to work out <pause dur="0.4"/> # what <pause dur="0.4"/> # the best strategy is <pause dur="0.4"/> if he doesn't invest <pause dur="0.3"/> then entry will occur <pause dur="0.4"/> and he will <pause dur="0.4"/> acquiesce <pause dur="0.9"/> on the other hand <pause dur="1.4"/> if he does invest <pause dur="0.8"/> then <pause dur="0.2"/> the entrant will stay out <pause dur="0.6"/> and he

won't in fact <pause dur="0.3"/> have to fight <pause dur="1.0"/> now the incumbent's <pause dur="0.4"/> # pay-offs are the second in these pairs of <pause dur="0.3"/> numbers <pause dur="0.6"/> and if he doesn't invest <pause dur="1.2"/> and entry occurs and he acquiesces he gets a pay-off of three <pause dur="1.0"/> whereas over here if he invests <pause dur="0.6"/> then it will pay the entrant to stay out <pause dur="0.7"/> and he will get a pay-off <pause dur="0.3"/> of four <pause dur="0.8"/> yeah </u> <pause dur="0.8"/> <u who="sm0764" trans="pause"> why do we not count on the bottom right on the slide </u><u who="nm0763" trans="overlap"> yeah </u> <u who="sm0764" trans="latching"> why do we not count the investment on that one <pause dur="1.7"/></u><u who="nm0763" trans="latching"> because of <pause dur="0.2"/> the # <pause dur="0.6"/> saving <pause dur="0.2"/> in costs that's effected by <pause dur="0.2"/> utilizing <pause dur="0.6"/> the investment the investment is a specific investment <pause dur="0.6"/> that <pause dur="0.4"/> reduces marginal costs <pause dur="0.8"/> that reduction in marginal costs <pause dur="0.4"/> is of particular value <pause dur="0.4"/> when you are wishing to expand capacity dramatically <pause dur="0.6"/> in order <pause dur="1.3"/> expand output dramatically because you have effected a major reduction in price <pause dur="1.7"/> so so the so the outlay on sunk cost is recovered <pause dur="0.7"/> by savings in variable costs <pause dur="0.3"/> under the conditions <pause dur="0.3"/> where the <pause dur="0.4"/> entrant enters the market and you fight <pause dur="0.7"/> if you decide not to fight <pause dur="1.4"/> then <pause dur="0.2"/> you don't drop the price <pause dur="0.3"/> the output doesn't need to increase <pause dur="0.3"/> and therefore <pause dur="0.2"/> you don't get substantial

savings so the savings only accrue <pause dur="1.0"/> in the event of a fight occurring <pause dur="1.2"/> you undertake the investment <pause dur="0.4"/> in order to give credibility <pause dur="0.5"/> to fighting <pause dur="1.1"/> but you don't in fact have to fight because your threat is credible <pause dur="0.7"/> so this is in fact an argument <pause dur="0.3"/> why firms will invest in unused capacity <pause dur="0.5"/> the final punchline of this model <pause dur="0.5"/> is <pause dur="0.2"/> with the firm investing capacity <pause dur="0.6"/> in order <pause dur="0.4"/> to reduce marginal cost <pause dur="0.4"/> which will give it a return <pause dur="0.5"/> in the case <pause dur="0.3"/> that it has to fight <pause dur="0.5"/> but the very fact that it has invested <pause dur="0.6"/> in <pause dur="0.7"/> reducing marginal costs <pause dur="0.3"/> means that its threat to fight an entrant is credible <pause dur="0.4"/> and that keeps the entrant out <pause dur="0.4"/> so what the incumbent has done is invest in capacity <pause dur="0.3"/> with the specific objective of not using it <pause dur="0.6"/> not having to use it to its full capacity <pause dur="0.4"/> in other words incumbent firms it is said <pause dur="0.5"/> it may invest <pause dur="0.3"/> in highly specific <pause dur="0.6"/> excess capacity <pause dur="0.5"/> specifically to keep the incumbents out <pause dur="0.5"/> and this <pause dur="0.2"/> as it were is quite useful because it explains a paradox that one <trunc>or</trunc> does observe <pause dur="0.4"/> in a number of

industries <pause dur="0.6"/> where they appear <pause dur="0.4"/> to have made investments that are <pause dur="0.3"/> unnecessarily specific <pause dur="1.0"/> unnecessarily large <pause dur="0.4"/> and not properly utilized <pause dur="0.4"/> and yet the firms are relatively profitable <pause dur="0.8"/> and <pause dur="0.4"/> the question why do they do it <pause dur="0.3"/> one answer may be <pause dur="0.3"/> that in fact it's not a case of a firm <pause dur="0.3"/> being incredibly inefficient and still managing to make a profit <pause dur="0.6"/> it actually makes a profit <pause dur="0.5"/> because although the wasted capital <pause dur="0.3"/> underutilized capital is socially inefficient <pause dur="0.8"/> privately it's efficient <pause dur="0.4"/> because it supports credible threats against entrants <pause dur="0.3"/> and therefore sustains the incumbent's monopoly power <pause dur="0.6"/> and so <pause dur="0.2"/> another consequence of that is <pause dur="0.3"/> the social costs of monopoly <pause dur="0.6"/> not only include <pause dur="0.4"/> the costs of higher prices <pause dur="0.3"/> the distortion <pause dur="0.3"/> of <pause dur="0.3"/> # buyers and consumers' decisions <pause dur="0.3"/> the social costs of monopoly are not merely to be found <pause dur="0.4"/>

in in price distortion <pause dur="0.4"/> and the distortion of consumer buying decisions <pause dur="0.4"/> they're also to be found <pause dur="0.3"/> in the fact that <pause dur="0.2"/> monopolized industries <pause dur="0.2"/> may well <pause dur="0.3"/> # <pause dur="0.8"/> employ <pause dur="0.4"/> excess <pause dur="0.2"/> and overspecialized capital <pause dur="0.4"/> for the specific purposes of deterring entry from the industry <pause dur="0.4"/> so those who are concerned <pause dur="0.4"/> # with # <pause dur="0.2"/> amplifying or <pause dur="0.2"/> finding the maximum possible social costs of monopoly <pause dur="0.3"/> often employ these kinds of arguments <pause dur="0.3"/> to suggest that the <pause dur="0.2"/> social costs of monopoly are found not only <pause dur="0.4"/> # on the consumer side of the situation <pause dur="0.4"/> but also on the capital investment <pause dur="0.3"/> # side of an industry as well <pause dur="1.2"/> okay <pause dur="0.2"/> it's quarter to five <pause dur="0.3"/> # i've had # six hours of lecturing today <pause dur="0.3"/> and i'm going home