Chapter 7 Flashcards
Define microdynamics
The term microdynamics is used to refer to the unfolding of competition, over time, among a small number of firms.
Define macrodynamics
The term macrodynamics is used to describe the evolution of overall market structure
What are the aspects of microdynamics
- The strategic benefits of commitment
- The informational benefits of flexibility
- A framework for analyzing commitments
- Competitive discipline
- Coordinating on the right price
What is an effective commitment
An effective commitment should restrict our freedom of action, either by directly limiting our options. For example, through the terms of a contract , or by making certain options so unattractive (financially, socially or emotionally) that we avoid them.
What is an strategic commitment
These are commitments that alter the strategic decisions of rivals
What does a strategic commitment need to be
If a commitment is to provoke a response, it must be irreversible, visible, understandable, and credible
When one firm chooses more of some action, such an output decision, and its rival firm cuts back on the same action, what kind of actions are these
Strategic substitutes
When one firm chooses more of an action and its rival chooses more as well, what kind of actions are these
Strategic complements
In the Betrand model, prices are
strategic complements because when one firm reduces prices, the other firm finds it profitable to reduce prices as well
In the Cournot model, quantities are
strategic substitutes because when one firm decrease its quantity, the other firm finds it profitable to also increase quantity
What is the direct effect of a commitment
The direct effect of the commitment is its impact on the present value of the firms profits if the competitor’s behavior does not change
What is the strategic effect of a commitment
The strategic effect takes into account the competitive side effects of the commitment
Whether a commitment has a profitable strategic effect depends on
Whether the commitment is tough or soft and whether the choices involve strategic complements or strategic substitutes
A firm’s tough commitment is
Bad for competitors for example capacity expansion
A firm’s soft commitment is
Good for competitors for example elimination of production facilities
What is the taxonomy of commitment strategies
This taxonomy bases commitment strategies on two important dimensions; whether commitments are tough or soft and whether the tactical variables are strategic substitutes of strategic complements
A strategic substitutes, tough and make
Top dog: assert dominance; force rivals to back off
A strategic substitutes, soft and refrain
lean and hungry look: actively submissive; posturing to avoid conflict
A strategic complements, tough and refrain
Puppy-dog ploy: placate top dog; enjoy available scraps
A strategic complements, soft and make
Fat-cat effect: confidently take care of self; share the wealth with rivals
The strategic effects of commitments are rooted in
inflexibility
How can a firm preserve its flexibility
A firm can separate a single large commitment into smaller components
By delaying important decisions, firms can:
learn more about market conditions
What does the study of real options answer
What is the best time to make a strategic investment when faced with uncertain conditions
When does a real option exist
When a decision maker has the opportunity to tailor a decision to information that is unknown today but will be revealed in the future
To illustrate real options analysis
consider the value of delaying a commitment
What is the framework for analyzing commitments
There a 4 analysis
- Positioning analysis
- Sustainability analysis
- Flexibility analysis
- Judgment analysis
Explain the positioning analysis
Positioning analysis can be likened to determining the direct effects of the commitment. It involves analyzing whether the firm’s commitment is likely to result in a product market position in which the firm delivers superior benefits to consumer or operates with lower costs than competitors
Explain the sustainability analysis
Sustainability analysis can be likened to determining the strategic effects of the commitment. It involves analyzing potential responses to the commitment by competitors and potential entrants in light of the commitments that they have made and the impact of those responses on competition. It also involves analyzing market imperfections
The culmination of positioning and sustainability analysis result in
The formal analysis of the NPV of alternative strategic commitments
Explain the flexibility analysis
Flexibility analysis incorporates uncertainty into positioning and sustainability analysis
Explain the judgement analysis
Taking stock of the organizational and managerial factors that might distort the firm’s incentive to choose an optimal strategy
What does the Cournot and Betrand model have in common
Total industry profit are less than what could be achieved if the firms acted like a cartel, choosing the monopoly price and output
What is tit-for-tat pricing
Once a market “leader” sets the collusive price, the others will follow. But if a firm tries to lower its price, others must match it in order to deter such disruptive business stealing
What are the two strategies that allow firms to sustain monopoly pricing as a noncooperative equilibrium
Tit-for-tat pricing
Grim trigger
What is the grim trigger strategy
The grim trigger strategy relies on the threat of an infinite price war to keep firms from undercutting their competitors prices
What is the folk theorem
If firms to expect to interact indefinitely and have sufficiently low discount rates, then any price between the monopoly price and marginal cost can be sustained as an equillibrium
What does the folk theorem imply
That cooperative pricing behaviour is a possible outcome in an oligopolistic industry, even if all firms act unilaterally
What are the impediments to coordination on tit-for-tat pricing
The misread problem
Lumpiness of orders
Information about the sales transaction
Volatility of demand conditions
Explain the misread problem
Tit-for-tat strategy assumes that firms can perfectly observe each other’s actions. But rivals will sometimes misread their rivals. By misread we mean that either (1) a firm minstakenly believes a competitor is charging one price when it is really charging anothter or (2) a firm misunderstands the reasons for a competitor’s pricing decision or its own change in market share
Explain lumpiness of orders
Orders are lumpy when sales occur relatively infrequently in large batches as opposed to being smoothly distributed over the year. (for example airframe manufacturing)
Explain information about the sales transaction
When sales transactions are “public,” deviations form cooperative pricing are easier to detect than when prices are secret
Explain volatility of demand conditions
Price cutting is harder to verify when market demand conditions are volatile and a firm can observe only its own volume and not that of its rival. If a firm’s sales unexpectedly fall, it will naturally suspect that one of its competitors has cut price and is taking business from it.
When does cooperative pricing become more difficult
When firms are not identical, either because they have different costs or are vertically differentiated.
Why when buyers are price sensitive it affects the sustainability of cooperative pricing
When buyers are price sensitive, a firm that undercuts its rivals’ prices by even a smal amount may be able to achieve a significant boost in its volume.
What are the 4 ways to facilitating cooperative pricing
Price leadership
Advance announcement of price changes
Most favored customer clauses
Uniform delivered prices
Explain price leadership
In price leadership, each firm gives up its pricing autonomy and cedes control over industry pricing to a single firm.
Explain advance announcement of price changes
In some market, firms will publicly announce the prices they intend to charge in the future
Explain most favored customer causes
A most favored customer clause is a provision in a sales contract that promises a buyer that it will pay the lowest price the seller charges
Explain uniform delivered prices
Under uniform delivered pricing, the firm quotes a single delivered price for all buyers and absorbs any freight charges itself
Explain uniform FOB pricing
Under uniform FOB pricing, the seller quotes a price for pickup at the seller’s loading dock, and the buyer absorbs the freight charges for shipping
Explain Sutton’s endogenous sunk costs
An endogenous sunk cost influences consumers’ willingness to pay for an individual firm’s product offering. Sutton classifies advertising as a key endogenous sunk cost. Advertising is a sunk cost because it is a fixed cost and often has limited salvage value.
What are disruptive technologies
Unexpected innovations that dramatically transform a products benefits and/or its costs of production
