Managerial EconomicsJack Wu

Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now

from price-based competition to marketing-based competition”,

Andrew Conway, Morgan Stanley

Coke vs. Pepsi, 1999

Competitive DilemmaPepsi

Raise price Discount

Raise price

C: 3, P: 3

C: 0, P: 5

Coke Discount C: 5,

P: 0 C: 1, P: 1

What should Coke do?

Strategic Situationsparties actively consider the interactions with

one another in making decisionsgame theory -- set of ideas and principles to

guide strategic thinkingsimultaneous actions: strategic formsequential actions: extensive form

Dominated Strategygenerates worse consequences than another strategy, regardless of the choices of the other parties

never use dominated strategy

Nash EquilibriumGiven that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy

• No one is willing to deviate unilaterally from a Nash equilibrium

Solving for Nash Equilibriumeliminate dominated strategies, then check

remaining cells“arrow” technique

Coke and Pepsi GameNash equilibrium: for both parties, “raise

price” is dominated by “discount”. but discounting is bad for both -- if only they

could agree somehow to raise price. Coke and Pepsi stuck in this situation for four

years until November 1999.

Radio FormatsMerkur

Lite AC no change

Jupiter

Hot AC J: 60,

M: 40

J: 60,

M: 40

no change J: 70,

M: 30

J: 50,

M: 50

Radio FormatsFor Merkur, “Lite AC” is dominated by “no

change”; so consider only “no change”, assuming Merkur chooses “no change”,

Jupiter should choose “Hot AC”.

Repeat using “arrow technique”.

Out of Nash EquilibriumWhat if another player doesn’t play Nash equilibrium strategy? Nash equilibrium strategy may not be best still don’t use dominated strategy

No Nash equilibrium in pure strategies

Competitor.com

NBA NHL

NBA W: 4, C: 3

W: 3, C: 4

We.com NHL W: 3,

C: 4 W: 4, C: 3

Where to advertise?

Randomized Strategieschoose among pure strategies according to

probabilitiesmust be unpredictableExample: retail market random discountExample: where to advertise_ We.com: ½ NBA and ½ NHL_ Competitor.com: ½ NBA and ½ NHL

Evening News:

TVB

7:30pm 8:0pm

7:30pm A: 1, B: 1

A: 3, B: 4

ATV 8:0pm A: 4, B: 3

A: 2.5, B: 2.5

Coordination and CompetitionPrime time for news is 8:0pm; second best is

7:30pm; since audience is limited, get maximum

viewership if two channels schedule at different times.

Question: which station gets 8:0pm? Situation has elements of

coordination -- avoiding same time slot competition -- getting the 8:0pm slot

Zero/Positive Sumzero-sum games: pure competition -- one

party better off only if other is worse offpositive-sum games: coordination -- both can

be better off or both worse offco-opetition: competition and coordination

Adopting Database SoftwareSol

IBM Oracle

Venus

IBM V: 1.5,

S: 1.5

V: 1,

S: 1

Oracle V: 1,

S: 1

V: 1.5,

S: 1.5

Focal PointNash equilibriummultiple Nash equilibria

SequencingGame in extensive form – sequence of moves:

nodesbranchesoutcomes

Extensive Form: Equilibriumbackward induction

final nodes intermediate nodes initial node

TVB

ATV

ATV

4, 3

2.5, 2.5

1, 1

3, 4

8:00

7:30

7:30

8:00

7:30

8:00

TVB, ATV

TV News: Sequential Moves

Strategic MoveAction to influence beliefs or actions of other parties in a favorable way

•credibility– first mover advantage– second mover advantage

Examples Examples: Evening TV news -- both stations want to move first: which one can?

Use strategic move, eg, contracts with advertisers to deliver news at 8pm.

Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder.

Issue: Is the move credible? Will it convince the other players?

Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is enemy

moving south or north? new product category -- let competitor test the market and educate the

customers

consumer

Litho

LithoMake prints

Do not

Buy

Do not

Make more prints

Do not

(1) serial number (2) destroying the plate(3) other solution?

Lithographer

Conditional Strategic Movesthreatspromises

Morgan Stanley:“Shareholder rights plan”

If any party acquires 15% or more of company’s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?

Shareholder Rights PlanThis shareholder rights plan is a threat to

potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder acquires

more than 15%, then rights triggered, and bidder will be diluted.

Nickname: poison pill. Actually works against shareholder rights -- by

entrenching existing management.

Sharon

Hilda

acquires 100,000shares

doesn’t bid

does not

activates rights

Hilda loses on initial stake + cost of takeover rises

Poison Pill

Union

Employer

reject union demand

accept

do not

strike Lose current wageand possibly gain infuture wage

Maintain current wage

Why are strikes rare inAmerican professional football?

Strike

AnswerStrike is a threat: must be credible, otherwise employer will

not raise wage; for threat to be credible, expected gain from strike in future

wage > loss of current wage.

American professional sports: football -- players have very short careers; if they strike for

one season, reduce professional careers by 20-25%. baseball -- long playing careers; strikes more common

depositor

bankmaintains deposit

run

Promise

withdraws deposit

remains solvent n.a.

?