Game Theory and Advanced

Game Theory and Advanced Pricing Techniques

Game Theory con't.

Decisions with One Dominant Strategy

1.  In the prisioners paradox both people had dominant strategies of confessing to the crime. They ended up spending 2 years in prision each when they could have spent only 1 if thet co-operated.

2.  If only one firm had a competetive advantage he would use

3.  The competitors would know what the firm is doing and make there decisions based on that.

4.  Dominated Strategies are strategies that are never chosed because other strategies have a higher payout Regardless of what the competition does (SLIDE 8)

5.  Successive elimination of dominated strategies – dominated strategies are eliminated. (Slide 9)

a) Palace will never choose a high price. At High – High each have 50% market share, at High – Medium Palace has lost significant market share at High – Low has lost most customers. So high is a dominated strategy for Palace

b) Likewise Castle would never pick a medium price no matter what the competion does.

6.  From the reduced Payoff table Place would choose Low ($6) p367

7.  Make Dominate(d) decisions not based on what you thing the competion will do.

Nash Equilibrium

1.  When managers do NOT have dominant or dominated strategies they need something else to base decisions on – Nash Equilibrium

2.  The manager wants the highest payoff for his firm and to do that he MUST correctly predict the moves of his competition

3.  Nash Equilibrium is a set of actions for which all managers choose their best actions given the actions of their competitors. (slide 12)

4.  Slide 13 shows Nash equilibrium

5.  Nash Equilibrium takes in account what you think the competition will do. Coke things Pepsi will go high so it goes high.

6.  Both would benefit more if they both went low.

Sequential Decisions

1.  Make a decision Tree (slide 19,20)

Strategic Moves (moves must be credible. Your competion must believe that such amove would be done)

1.  Comitments – announcing or demonstrating that you will do something and it is irreversable

2.  Thrests – If you do A, I will do B which will hurt you

3.  Promises – If you do A, I will do B which will help you.

Pricing Tactics

1.  Price Matching – commitment to match rivals price

2.  Sale-price guarantee – Buy today and we price it lower in the 30 days will refund you the difference

3.  Price-leadership a firm sets the Oligoply (industry is all firms Demand) profit maximizing price and competitors have to follow

4.  Cartels

5.  Collusion - against the law

6.  Tacit Collusion – no explicit agreement between members of an Oligopoly

Strategic Entry Deterrence

Established firms in an Oligopy move decisions that make it difficult for other firms to enter the market therefore limiting competition

1.  Limit Pricing – The established firm sells its product below profit maximization to prevent market entry. Takes the economic profits out of entering

2.  Capacity Expansion – The established firm irreversably expand production capacity with the threat it will reduce prices on entry.

ADVANCED PRICING TECHNIQUES

Price Discrimination – When the market permits it firms wish to avoid “uniform pricing” and discriminate.

1. Uniform Pricing is the same price for all buyers.

2. Some people are willing to pay 10 for a product and others only 5. If I sell for 5 all buy but I loose the extra 5 in revenue per person willing to pay

3. Economists believe if you can separate buyers into different groups with different elasticities then you can add profits by price discrimination.

4. If you take an identical and sell it under two brands (one appealing to those who will pay 10 and one for the group that will pay 5) that is not price discrimination but adjusting reference value in Price Theory.

5. To be price discrimination the products must be perceived as identical not just actually identical.

First Degree (or perfect) Price Discrimination

1)  1.Every unit is sold for the maximum each consumer is willing to pay

2)  Not really achievable

3)  Closest thing is auctions and scalping tickets.

4)  Different buyers compete to buy the product

Second Degree Price Discrimination

1. Offers lower prices for larger quantities purchased

2. Student or Senior discounts

3. Coupons

4. Membership Cards – Discount if you have the card

Cost Plus Pricing

1. Can only be done with firms with Market Power

2. ATC + a profit margin

Government involvement in the economy