Can you please explain this using \"Walmart\" as an example? “Game Theory in Glo
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Question
Can you please explain this using "Walmart" as an example?
“Game Theory in Global economy” with “Strategic moves”
482 PART FOUR Market Structure and Pricing Practices forgiving enough to ailow a pattern of mutual cooperation to develop. In computer tion as well as in actual experiments, a tit-for-tat behavior was found to be consistently best strategy (i.e, the one that resulted in the largest benefit) for each player over time. For a tit-for-tat strategy to be best, however, certain conditions must be met. Fis requires a reasonably stable set of players. If the players change frequently, there is n chance for cooperative behavior to develop. Second, there must be a small number of pa ers (otherwise, it becomes very difficult to keep track of what each is doing). Third. » assumed that each firm can quickly detect (and is willing and able to quickly retaliate f cheating by other firms. Cheating that can go undetected for a long time encourages chea ing. Fourth, demand and cost conditions must be relatively stable (for if they change idly, it is difficult to define what is cooperative behavior and what is not). Fifth, we assume that the game is repeated indefinitely, or at least a very large and uncertain nue of times. If the game is played for a finite number of times, each firm has an incentive to cooperate in the final period since it cannot be harmed by retaliation. However, firm knows this and thus will not cooperate on the next-to-the-last move. Indeed, effort to gain a competitive advantage by being the first to start cheating, the entire tion will unravel, and cheating begins from the first move. There are, of course, times when a firm finds that it is to its advantage not to coope For example, if a supplier is near bankruptcy, a firm may find every excuse for not pay bills to the near-bankrupt firm (claiming, for example, that supplies were defective or did meet specifications) in the hope of avoiding payment altogether if the firm does go out of hu ness. It is the necessity to deal with the same suppliers and customers in the future and de ability to retaliate for noncooperative behavior that often forces a firm to cooperate. W tit-for-tat strategy, however, it is possible for firms to cooperate without actually resorting collusion. As we will see in Chapter 13, this can be a nightmare for antitrust officials. 11-6 STRATEGIC MOVES In this section we examine games involving threats, commitments, credibility, and deterrence. These concepts greatly enrich game theory and provide an important elemn of realism and relevance. Threat, Commitments, and Credibility Oligopolistic firms often adopt strategies to gain a competitive advantage over their r even if it means constraining their own behavior or temporarily reducing their own pro For example, an oligopolist may threaten to lower its prices if its rivals lower theirs, if this means reducing its own profits. This threat can be made credible, for example, written commitment to customers to match any lower price by competitors. For example, suppose that the payoff matrix of firms A and B is given by Table This payoff matrix indicates that firm A has the dominant strategy of charging a hi price. The reason is that if firm B charged a low price, firm A would earn a profit of 2 See R. Axelrod. The Evolution of Cooperation (New York: Basic Books, 1984). "See D. Kreps, P. Milgron. J. Roberts, and R. Wilson, "Rational Cooperation in the Finitely Repeated Prisoners' Dilemma." Journal of Economic Theory (1982), pp. 245-252Explanation / Answer
First of all let us understand what an Oligopoly market is. It is a market where the majority of the market share is held by a few (although not a strict rule but generally 2-3) players. In essence the few number of players ensures the moves of each player greatly impacts the whole industry and the competitors’ business.
Now the chapter is trying to explain us different strategic moves (like Threats, entry deterrents) which are played between oligopolistic market players.
For our example let us assume there are only 2 firms in the offline retail market firm A represented by Walmart and Firm B represented by Target Inc.
Hence as evident from the payoff matrix Walmart earns an overall profit of $2 (just a representative number) when it plays a low price strategy and earns an overall profit of $3 or $5 depending on what pricing strategy (low or High) is played by Target.
Hence very clearly Walmart does not need to bother about Target’s strategy when it comes to decide between its’ own low prices or high prices strategy. It will always be High prices strategy. But as there is nothing like enough money Walmart would try to play mind games with target and somehow make them play high prices strategy so that they earn $5 rather than $3.
How would they do that? They would threaten Target that if they play low prices, Walmart will also play low prices and thus both of them will suffer and earn $2 only. This threat is believable by target only if in the past Walmart have acted as per their threats even if it makes both the parties to suffer. In that case Target would believe the threat to be convincing and keep their prices high (as desired by Walmart).
In case target knows that the threat is just a bluff (as in the past also Walmart said so but never acted so), they would play their low prices strategy so that they earn $4.
A similar strategy can be played by Walmart in order to deter/hinder a new player (represented by firm B) from entering the market. Ideally they would keep their prices high as in that case they would either earn $7 or $10 depending on whether or not the new player enters. But they would like to earn $10 and thus would threaten the new player to not enter else they would drop prices and the new player would either not make profits or make losses of $2.
The new player will believe the threat to be true if Walmart has proven in the past that it can bleed in order to make others prohibit to enter the market. Else the new competitor will take it as a bluff and enter the market.