11: Introduction to Strategic Behavior

• Non-price competition in oligopoly is inherently strategic
• Objective of non-price competition in oligopoly

  To change the outcome of price and output competition favorably
• Examples of non-price competition

  • After Sales Service
  • Sponsorship Deals
  • Brand Names
  • Publicity
  • Free Delivery
  • Special Features
  • Sales Promotion
  • Packaging
  • Advertising
  • Personal Selling
• Commitment


  A credible promise or threat
• Noncredible threats or promises are not in an agents self-interest to carry though
• Strategic moves


  Convert threats or promises into commitment
• Ways commitments can be made

  • Public pronouncements
  • Linking with an outside base
  • Increasing the prominence of demands
  • Reinforcing the threat or promise
• Direct effect of strategic move


  Changes the choices or payoffs of rivals
• Indirect effect of strategic move

  Changes the behaviors of rivals through a change in their expectations of optimal behavior
• Strategic moves build a competitive advantage

  • Innovation
  • Partnership
  • Customer Experience
  • Knowledge
  • Cost
• Strategic choices


  Have long term impact, involve top level decisions
• Tactical choices


  Have short term impact, involve middle level decisions
• Operational decisions


  Involve getting tasks done
• Pricing decisions are often tactical because they can be changed quickly and without incurring sunk expenditures
• Decisions about non-price are often strategic because they cannot be changed quickly and involve sunk expenditures
• Strategic decisions determine the choice set and payoffs of tactical decisions
• Stackelberg game


  A leader-follower model where the leader commits to its quantity before the follower decides how much to produce
• When best response functions slope downward, the marginal revenue of a firm is decreasing in the output of its rival, so the first mover anticipates that the follower will respond to increases in output by the first mover by reducing its output
• This increases the marginal revenue of the first mover relative to the Cournot game, providing it with an incentive to increase its output
• The output of the leader is greater, the output of the follower is smaller, and the aggregate output greater relative to the Cournot game
• First-mover advantage

  The assumed commitment in the Stackelberg game to output by the leader provides it with a strategic advantage that leads to greater profits
• The efficiency of the Stackelberg game relative to the Cournot game depends on the change in output and change in costs
• Limit output


  The minimum output for an incumbent required to make the profits of an entrant nonpositive
• When firms produce homogenous products and there are constant returns to scale, entry deterrence is not profitable, and an incumbent will always find it more profitable to accommodate entry
• When output is homogeneous and there are economies of scale, profitable entry deterrence is possible
• Black-Scholes-Merton (BSM) model of limit pricing


  Assumes the entrant believes the incumbent will produce the same amount after entry as before, in which case an incumbent can deter entry by producing the limit output
• The Stylos Postulate is a noncredible threat: an incumbent would typically find it profit maximizing to accommodate entry by reducing output