dewevu BBS. MITLIBRARIES 3 9080 03317 5990 Massachusetts Institute of Technology Department of Economics Working Paper Series AGGREGATE COMPARATIVE STATICS Daron Acemoglu Martin Kaae Jensen Working Paper 09-09 February 22, 2009 RoomE52-25l • 50 Memorial Drive Cambridge, MA02142 This paper can be downloaded without charge from the Social Science Research Network Paper Collection at http://ssrn.com/abstract=1374641 Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium Member Libraries http://www.archive.org/details/aggregatecomparaOOacem Aggregate Comparative Statics" Daron Acemoglu^ and Martin Kaae Jensen1 February 22, 2009 Abstract In aggregative games, each player's payoff depends on her own actions and an aggregate of the actions of all the players (for example, sum, product or some moment of the distribution of actions). Many common games in industrial organization, political economy, public economics, and macroeconomics can be cast as aggregative games. In most of these situations, the behavior of the aggregate is of interest both directly and also indirectly because the comparative statics of the actions of each player can be obtained as a function of the aggregate. In this paper, we provide a general and tractable framework for comparative static results in aggregative games. We focus on two classes of aggregative games: (1) aggregative of games with strategic substitutes and (2) "nice" aggregative games, where payoff functions are continuous and concave in own strategies. We provide simple sufficient conditions under which "positive shocks" to individual players increase their own actions and have monotone effects on the aggregate. We show how this framework can be applied to a variety of examples and how this enables more general and stronger comparative static results than typically obtained in the literature. "We would like to thank Roger Hartley, Jean-Francois Mertens, Alex Possajennikov, and Burkhard Schipper for their helpful remarks and suggestions. Thanks also to seminar participants at the University of Copenhagen, University of Manchester, and at the 2008 Midlands Game Theory Workshop in Birmingham. All remaining errors are of course our responsibility. department of Economics, Massachusetts Institute ofTechnology (e-mail: [email protected] ) 'Department of Economics, University ofBirmingham, (e-mail: [email protected]) 1 Introduction In aggregative games, each player's payoff depends on her own actions and some aggregate of all players' actions. For example, the Cournot model of oligopoly competition is an aggregative game; each firm's profits depend on its own quantity and total quantity supplied to the market. More generally, the aggregate could be any mapping from the players' action profile to a real number.1 Numerous games studied in the literature can be cast as aggregative games. These include the majority ofthe models ofcompetition (Cournot and Bertrand with or without product differentiation), models of (patent) races, models of contests and fighting, models of public good provision, models with aggregate demand externalities, and so on. In many applied problems, the focus is naturally on how the aggregate (e.g., total supply to the market, the price index, probability of innovation, total public good provision) responds to changes in the environment. In addition, comparative statics of individual actions can often be obtained as a function of the aggregate.2 In this paper, weprovide asimplegeneral frameworkfor comparativestatic analysis in aggrega- tive games. Our approach is applicable to diverse environments that can be cast as aggregative games and enables us to provide sufficient conditions for a rich set of comparative static results. We present two sets of results. First, we focus on aggregative games with strategic substitutes. In games with strategic substitutes, each player's payoff function is supermodular in her own strategy and exhibits decreasing differences in her own strategy and the strategy vector of other players. For aggregative games with strategic substitutes, we establish the following results: 1. Changes in parameters that only affect the aggregate (such as a shift in demand in the — Cournot game) always lead to an increase in the aggregate in the sense that the smallest and the largest elements of the set of equilibrium aggregates increase. 2. Entry ofan additional player decreases the (appropriately-defined) aggregate ofthe existing players. 3. A "positive" idiosyncratic shock, defined as a parameter change that increases the marginal payoff of a single player, leads to an increase in that player's strategy and a decrease in the other players' aggregate. 'We discuss games with multi-dimensional aggregates in Section 7. 2The fact that a game is aggregative does not imply that players ignore the impact of their strategies on aggregates. When they do so, we say that the equilibrium is Walrasian Nash or that the play is Walrasian. Our results are generalized to Walrasian Nash equilibria in Section 9. Because in this case there are more more limited "game-theoretic" interactions, the analysis is more straightforward. The comparative static results mentioned above are intuitive. But it is surprising that for aggregative games, they hold at the same level of generality as the monotonicity results for supermodular games (in particular, no quasi-concavity or convexity assumptions are needed). Nevertheless, not all aggregative games exhibit strategic substitutes. The second set of results we present focus on "nice" aggregative games, which are games with payoff functions that are continuous, concave (or pseudo-concave) in own strategies, and sufficiently smooth (in particu- lar, twice continuously differentiable). Many games analyzed in industrial organization, political economy and other areas satisfy these conditions. An example is contest (or fighting) games, where payoffs are determined by the effort levels of all players; contests typically exhibit neither strategic substitutes nor complements. Another example is provided by games in which players make voluntary contributions to the provision of a public good. We prove parallel results for nice aggregative games under an additional technical assumption, which we refer to as local solvability. Under this assumption, which ensures the local invertibility of the "backward reply" mapping described further below, we establish a general monotonicity theorem similar in spirit to the monotonicity results for supermodular games. This theorem implies that a positive shock to (one or more of) the players leads to an increase in the smallest and largest equilibrium values of the aggregate. We also prove that entry of an additional player increases the aggregate and derive more extensive "individual comparative static" results. An informal summary of our results from both aggregative games with strategic substitutes and from nice aggregative games is that, under a variety of reasonable economic conditions, comparative statics are "regular" (for example, a reduction marginal cost increases output and so on). Nevertheless, it should be emphasized that there is no guarantee that such intuitive results should hold generally. The next example illustrates how counterintuitive, "perverse," results can arise in simple games, even in simple aggregative games. Example 1 Consider three players i = 1,2,3 with payoff functions 7Tj(s) = —0.5s? + a,(l — a'j)_1(X^7=H sj)si + ft(l — &i)~1Si defined locally in a sufficiently large neighborhood of the equi- librium found below. Assume that a\ > 1, 1 > a2 > 0, Q3 < 0, 0\ < 0, 2 > 0, Qi + a2 + Q3 > 1, 01 + 02 +03<O, and Ql + a3 < 1. This is an aggregative game since we can write the payoffs as a function of players' own strategies and the aggregate Q = Ylj sj: ^k{suQ) = -O.5s^+al(l-al)~1(Q-sl)sl+0l{l-al)~lsi. By strict concavity, best response functions in this game are: ri(s-t) = aj(l — cti)~1(J21jH sj) + 0i(l — at)"1. Solving for the pure strategy Nash equilibrium (s* = ^(s^), i — 1,2,3) we obtain s* = atQ* + 0i, where Q* = s{ + s$ + S3 = (0i + 2 + 03)~1(l - ai — 02 - a3) is the equilibrium aggregate. Now consider a (small) increase in a2. This is a "positive shock" to player 2: holding opponents' strategies fixed, it increases player 2's marginal payoff and therefore "lifts" player 2's best response function,3 dr2(s-2)/doi2 > 0. yet But this positive direct effect on player 2's optimal strategy notwithstanding, an increase in ao leads to a decrease in player 2's strategy in equilibrium: %9-s**i- = „Q-, +, Q2Td,Q* = -, ft + ft + ft +, CX2J- ft + 02 + 03 ro ^< n As can also be seen, the positive shock to player 2 leads to a decrease in the equilibrium aggregate: dQ* <0 7ora- - 2 In summary, a parameter change that unambiguously increases the marginal payoff for a player, which should, all else equal, lead to an increase in that player's strategy and the aggregate, in fact leads to a decrease in the player's strategy in equilibrium as well as a decrease in the aggregate. Part ofthe contribution ofour paper is to provide minimal conditions to ensure that "perverse" results, such as those described in the previous example, do not apply. In particular, such results are ruled out in nice aggregative games by the local solvability assumption mentioned above. In addition to providing minimal conditions for general comparative static results and significantly weakening the conditions that are available in the literature (for example, for models of patent races, contests, and public good provision), our approach is also useful because it highlights the common features that ensure "regular" comparative static results. These results are made possible by the alternative approach we use for deriving comparative static results (the more familiar approaches in the literature rely on the implicit function theorem and lattice-theoretic tools in the case of supermodular games). Our approach can be explained as follows. Consider a general comparative static problem written as A • ds = —b-dt, where dt G R is the change in some exogenous variable, ds G R^ designates the induced change in the endogenous variables, A is an M x M matrix and b is an Af-dimensional vector. An — important question is to specify the conditions under which we can sign ds "robustly" meaning A without specifying numerical values for the elements of the matrix and vector b. Cast in this generality, the conclusion is somewhat depressing: to obtain such results it is necessary to ascertain the sign of the elements of A-1. But even when A is symmetric negative definite, we In other words, player 2's payoff function exhibits increasing differences in S2 and Q2 (Topkis (1978)). This is an equivalent way of defining a "positive shock" when strategy sets are one-dimensional and payoff functions are can do this only when one of the following two additional (and stringent) conditions hold: (i) when A is a Metzler matrix, that is, it has non-negative off-diagonal elements, or (ii) when A is a Morishima matrix, that is, it becomes a Metzler matrix when we reverse the sign of one or more variables.4 The only general case where these conditions are satisfied is provided by supermodular games. Since many games that arise in applications are not supermodular, much of the applied literature imposes additional parametric restrictions in the context of specific games to derive comparative statics results. The discussion above highlights that many of these conclusions may not be robust and in general there are no systematic investigations ofwhen the specific conclusions enjoy such robustness. Our alternative approach is not to impose parametric restrictions, but to exploit the aggrega- tive nature of the games in question and note that what is often of economic interest is not the entire vector ds, but the behavior ofthe appropriate aggregate, or just one of its coordinates (the latter corresponds to deriving robust results for a single player as opposed to all players). With this perspective, robust and general comparative static results can be obtained under considerably weaker conditions. Our contribution is to suggest this perspective and show how it can be made operational. Our paper is related to a number of different strands in the literature. Comparative static results in most games are obtained using the implicit function theorem. The main exception is for supermodular games (games with strategic complements). Topkis (1978, 1979), Milgrom and Roberts (1990) and Vives (1990) provide a framework for deriving comparative static results in such games. These methods do not extend beyond supermodular games. More closely related to our work, and in many ways its precursor, is Corchon (1994). Corchon (1994) provides comparative static results for aggregative games with strategic substitutes, but only under fairly restrictive conditions, which, among other things, ensure uniqueness of equi- libria. These conditions are typically not easy to check in many applied problems. In contrast, we provide general comparative static results for aggregative games with strategic substitutes without imposing any additional assumptions. We also provide parallel but stronger results for nice aggregative games without strategic substitutes. Another similarity between our paper and Corchon (1994) is that both make use of the so-called backward reply correspondence of Selten (1970). In an aggregative game, the backward reply correspondence gives the (best response) strategies of players that are compatible with a given value of the aggregate.5 In a seminal paper, 4See Bassett et al (1968) and Hale et al (1999). The first systematic study ofaggregative games (German: aggregierbaren Spiele) can be found in Selten (1970). After defining aggregative games, Selten proceeds to define what he calls the Empassungsfunktion (Selten (1970), p. 154), that is, the backward reply function of an individual player. As Selten proves, the backward reply correspondence is single-valued (a function) provided that the player's best-response function has slope greater Novshek (1985) used this correspondence to give the first general proof of the existence of pure- strategy equilibria in the Cournot model without assuming quasi-concavity of payoff functions (see also Kukushkin (1994)). Novshek's result has since been strengthened and generalized to a larger class of aggregative games (e.g., Dubey et al. (2006) and Jensen (2007)) and our results on games with strategic substitutes utilize Novshek (1985)'s construction in the proofs.6 Our results on "nice" aggregative games blend the backward reply approach with the equilibrium comparison results reported in Milgrom and Roberts (1994) and Villas-Boas (1997).7 The rest of the paper is organized as follows. Section 2 provides basic definitions. Section 3 presents a number of common examples, which can be cast as aggregative games. Section 4 provides the general comparative static results for aggregative games with strategic substitutes. Section 5 generalizes and strengthens these results for "nice" aggregative games, which feature payoffs that are continuous and (pseudo-)concave in own strategies. Section 6 shows how the results from Sections 4 and 5 can be used to obtain general characterization results in various ap- plications. Section 7 discusses how these results can be extended to games with multi-dimensional aggregates and Section 8 provides additional generalizations of the results presented in Section 5. Section 9 briefly discusses Walrasian Nash equilibria (cf. footnote 2). Section 10 concludes and the Appendix contains the proofs omitted from the text. 2 Basic Definitions In this section, we introduce some basic definitions. Let r = (iri,Si,T)l€ j denote a noncooperative game with a finite set ofplayers 1 = {1,...,/}, N M and finite-dimensional strategy sets 5, C R . In addition, T C R is a set of exogenous pa- rameters with typical element t € T. We will focus on how the set of equilibria of T changes in response to changes in t. Throughout the rest of the paper we assume that the joint strategy set than —1. The assumptions imposed by Corchon (1994) imply that the slope ofplayers' best-response functions lie strictly between -1 and 0, so that thebackward reply correspondence is bothsingle-valued and decreasing. Neither is necessarily the case in many common games and neither is imposed in this paper. 6Novshek'sexplicitcharacterizationofequilibriaissimilartothecharacterizationofequilibrium insupermodular games that uses the fixed point theorem ofTarski (1955). Both of these enable the explicit study of the behavior of "largest" and "smallest" fixed points in response to parameter changes. Tarski's result is used, for example, in the proofofTheorem 6 in Milgrom and Roberts (1990). More specifically, our proofs repeatedly use that the smallest and largest fixed points ofa continuous function from a subset of real numbers into itself will increase when the curve is "shifted up" (see Figure 1 of Villas-Boas (1997) or Figure 2 of Milgrom and Roberts (1994)). is compact (in the usual topology) and the payoff functions S x T -> R TTj : are upper semi-continuous for each i E X. Let Ri{s-i, t) = argmax^(s,, s_2, £) •s,e5, denote the bestresponse correspondence (with the standard notation S-i 6 S-i = Yijjti Sj)- Given the compactness and upper semi-continuity assumptions, the correspondence Ri is non-empty- and compact-valued, and upper hemi-continuous. We next define the notion of an aggregator. Definition 1 (Aggregator) A mapping g : S —» R^ (with K < N) is an aggregator if it is continuous, increasing and separable across the players, i.e., if there exists a strictly increasing function H : RK —> R^" and increasing functions hi : St —> R^ (for each i£l) such that: (1) K Throughout this paper is referred to as the dimension of the aggregate. For most of the analysis (in particular, until Section 7), we impose K = 1, but throughout there are no restrictions on N. In particular, except Corollary 3 in Section 8, none of our results require N — 1 (one- dimensional strategy sets). The requirement that g is increasing in s ensures that both g and —g cannot be aggregators for the same game. Naturally, since we can change the order on individual strategies (thus working with —sl instead of Sj for some i), this requirement is not very restrictive. Common examples, such as the sum ofstrategies g(s) — X^?=i sj> satisfy the definition ^ (with hi(si) = Si and H(z) = z). Two other simple examples are g(s) — (ajSj 4- . .. + oms'n)1 , S C RN, and g(s) = ^=1^, S C R^_+ where ay > (for each j) and > 0, which are, respectively, a CES function and a Cobb-Douglas function.8 Remark 1 (Differentiability and Aggregation) In the case of one-dimensional strategy sets, Definition 1 is the standard definition of separability when g is strictly increasing (see, e.g., Gorman (1968)). It can be easily established that when g is twice continuously differentiable, Ar = K = 1, and / > 3, it is separable if and only if the "marginal rate of transformation" between any two players i and j is independent of the other players' actions; that is, D Ds,g(s) = hij(si, Sj) for all s 6 S (2) g(s) S3 8In the first case /ii(ss) = Q^sf (with Si > 0) and H(z) = zl/a. In the second hi(st) = a;log(s,) and H(z) = exp(z) (again with Si > 0).