Lecture 1/Module 1

Question 1

Strategy

Answer 1

A complete plan for every contingency.
Takes into account what others can be reasonably expected to do.
Interested in what other people have done/may do.

Question 2

Players

Answer 2

Consumers (are strategic–net consumers in price shopping/comparing prices–$10 @ WalMart vs $20 @ Target), Suppliers (upstream), Complementors (downstream), Rivals

Question 3

Complementor

Answer 3

Hardware/Software

ex: Supermarket is complementor for laundry detergent to help get them to customers.

Question 4

Optimum and Equilibrium

Answer 4

Optimum: That which is best.
Equilibrium: When everyone is at their best response (not best decision).
1) Single person decision
2) Multi-person decision
    a) Best response
    b) Equilibrium

Question 5

Value Net

Answer 5

In order to produce the value, consumer must make a purchase and use the item. The frozen dinner depends on the consumer having a freezer and microwave (complementors). Also depends on suppliers to make sure frozen dinner is preserved in packaging. Competitors hike/rise price.

A conceptual way of thinking about the fact that what gthe consumer gets out fo our offer really deoends on a whole host of people that can act individually. However, we can study the interactions systematically.

Question 6

Nash Equilibrium

Answer 6

Content Needed

Question 7

Principle of Optimality: at the optimum we set

Answer 7

MC (marginal cost) = MR (marginal revenue)

If MC is LESS than MR, put in more effort.
If MC is HIGHER than MR, put in less effort.
Equal is good.

Question 8

Conundrum of Best Response

Answer 8

Things could be better, but they’re not when we give in to Best Response in context to our situation (involving other people we cannot control). Does not mean full effort is given.

Question 9

Co-opetition

Answer 9

Cooperation/Competition – Pie Graph

You’d like to cooperate, but you are competing.
Instead: FIRST, cooperate. NEXT, compete to make the pie bigger.

Communication in the beginning about what process will be going through to make sure time and money isn’t wasted.

The pie is smaller because they are all at their best response, so they have to get away from their best response.

Question 10

Demand Curve

Answer 10

Price goes up–Demand shrinks.

Price goes down–Demand rises.

Question 11

Demand Formula

Answer 11

𝑆=𝐴−𝐵𝑝 if price is p

Question 12

Profit Formula

Answer 12

𝜋=(𝑝−𝑐)(𝐴−𝐵𝑝) if variable (marginal) cost is c

Question 13

We know that to maximize 𝜋, the optimal choice of 𝑝 is

Answer 13

𝑝^∗=0.5(𝐴/𝐵+𝑐)

Question 14

A strategy is…

Answer 14

A complete action plan to accomplish a goal that could be a battlefield goal or more often a political goal.

Question 15

How do you develop a strategy?

Answer 15

By taking into account how the opponent would act and how the units that support the strategy would act in tandem.

Question 16

What makes a plan good?

Answer 16

When it’s in the context of others’ plans.

Question 17

What is the best outcome for a firm?

Answer 17

One that maximizes profits.

Question 18

Another aspect of the strategic interaction between consumers and firms has to do with…

Answer 18

the long-term relationship that involves repeated interactions.

Question 19

Firms place a premium on having “satisfied” customers because…

Answer 19

having the consumer’s confidence in the quality of a firm’s offering and the consumer’s trust in the firm’s communications is key to maximizing long-run profits. Keeping that in mind it could even make sense to sacrifice immediate profits on occasion.

Question 20

Rivals

Answer 20

Those that are competing for the same consumer-exchange outcome. In some cases it could be helpful to include among rivals other firms collaborating with the same partners.

Question 21

Value Net

Answer 21

Web of Interactions: Strategic interaction occurs between the firm on the one hand and consumers, suppliers, complementors and rivals on the other hand.

Question 22

What does the optimum depend on?

Answer 22

What others are doing. More generally, you want to know what others are thinking of doing.

Question 23

John Mayanrd Keynes is reported to have said

Answer 23

“Successful investing is anticipating the anticipations of others”. Indeed, an optimal decision depends on what others can be expected to do. A seller’s optimal decision must anticipate how consumers, partners and rivals behave.

Question 24

Rational Expectations

Answer 24

Anticipations are called expectations and expectations that are correct in the sense that they actually come to pass are called rational expectations.

Question 25

Best Response

Answer 25

If an action is optimal given what other agents do.

Question 26

Equilibrium

Answer 26

When all agents are at a best response, clearly none of the agents has an incentive to choose an action other than what they chose. And so, they stay put. When nobody wants to change their decision because all agents are at their best response, such an outcome is called an equilibrium.

Question 27

John Nash proved that…

Answer 27

…in almost all situations of strategic interaction we can indeed find an outcome in which each agent is at a best response. For this reason, an equilibrium is often also referred to as a Nash equilibrium.

Question 28

One of the interesting properties of a Nash equilibrium is…

Answer 28

…even though each agent is at a best response all the agents collectively may not be at an “optimum”.

Question 29

Co-opetition

Answer 29

Brandenburg and Nalebuff suggest that sophisticated managers are better off developing competitive strategies that recognize the benefits of co-operation in making the pie larger. They call this approach co-opetition.

Question 30

Tit for tat strategy

Answer 30

Each store wants to attract customers, and one way of doing this is to advertise lower prices. In particular, customers who find one store convenient may nevertheless shop at the other if the price at the latter were lower. Convenient location is trumped by lower prices. In this case what can the first store do? Suppose it follows a policy of matching prices, which says that a customer who finds lower prices at the second store can buy products at the first store at the lower price. So any customer exposed to the second store’s advertisement could obtain the lower prices without foregoing the convenience of the first store! This sort of price matching is more generally a tit for tat strategy that takes away the advantage of lower prices. When both stores follow a price matching strategy, the result is that each store obtains customers who find it convenient and neither store finds it worthwhile to advertise low prices.

Question 31

Can firms achieve higher levels of advertising to increase the size of the pie by adopting a tit for tat strategy?

Answer 31

No

Question 32

Cheap Talk

Answer 32

Suppose in the crowdfunding example, donor 1 decides to tell donor 2 what she intends to do. Of-course there is no rule that she must speak the truth. And, what she says will not affect the outcome, only what she does. So, we say this is cheap talk. Still, if what she says affects what donor 2 would do, even cheap talk could affect the outcome, indirectly.

Question 33

Even if you’re not bluffing, you’re still mesing with who’s heads?

Answer 33

Competitors and ESPECIALLY the consumers

Question 34

What is a meaningful contract?

Answer 34

The contract tells each party what they are responsible for.

Verifiable of action: Is it enforceable by law?

Individual Rationality: Are the contract terms acceptable to both (all) parties? (Is there a benefit over outside options? Can you buy cheaper with rebate?)

Incentive Compatibility: Make sure the contract does not contain incentives for agents to lie. Don’t expect them to be honest if you provide an incentive.

–Ex: provide standing desk for people wth pain? people may lie about having pain to get a standing desk.

Question 35

wholesale price

Answer 35

determines the retail price

Question 36

the size of the pie is…

Answer 36

…the retailer’s profit +the manufacturer’s profit

–smaller than if there is no retailer

Question 37

can we write a contract b/w r and w so that the pie does not get smaller?

Answer 37

when you have a contract that makes sure each party would make just as much/more without the contract

Question 38

Tit-for-tat

Answer 38

Tit-for-tat is a sort of punishment strategy. You simply follow or imitate what the other does

Question 39

Tit-for-tat

Answer 39

Tit-for-tat is a sort of punishment strategy. You simply follow or imitate what the other does.

Consider two supermarkets
WE WILL NOT BE UNDERSOLD!
YOU CUT PRICE I WILL CUT TOO!
So one raises price, then the other can also raise price

Price matching — tit-for-tat —leads to higher, co-operative pricing

“I take away the incentive for you to do something bad. If you mess with me, then I’m going to mess with you.”

Question 40

Does Tit-for-Tat always work?

Answer 40

Might actually lead to higher prices.

Depends on many things
For one, it must pay the other to follow suit
For example in the franchisee free riding problem
If one franchisee increases advertising, it pays the other to decrease its advertising, so go opposite
In this case tit-for-tat won’t work
WE MAY NEED PUNISHMENTS!
Follow suit is also called strategic complement and go opposite is called strategic substitute

Question 41

Repeated Encounters

Answer 41

Imagine two firms that want to charge prices higher than Nash equilibrium prices so that profits are higher at 𝜋.
Can they sustain that?

Let us they start off cooperating at higher price. One firm says let me cut price and make extra money!
Extra money of $K (incremental profit)

The other guy says I am going to teach you a lesson. I am cutting price to zero, so you will make zero profits instead of the agreed upon 𝜋.
So every period that the price is zero, there is a “loss” of 𝜋! Over many periods if this accumulated loss is more than the extra money $K, then the firm that “deviated” has a net loss. The threat of such punishment stops any deviation!

It is the threat, not the actual punishment. Since there is no deviation, there is no need for punishment to be meted out!

Question 42

When Does Cheap Talk Work?

Answer 42

For coordination
The two players’ interests must coincide or at least be positively correlated
Mistakes by one or the other should not be excessively costly to the other.