Lecture Unit 6: Dynamic competition across time (3/3)

Question 1

What are impediments to coordination?

Answer 1

• The Misread Problem
• Lumpiness of orders
• Information availability regarding sales transaction
• Volatility of demand conditions
• Asymmetries among firms

Question 2

What happens when it is possible to misread a rival’s move in a tit-for-tat strategy? (Performance)

Answer 2

tit-for-tat may not perform as well as more forgiving strategies

Question 3

What are two scenarios where misread can happen?

(Impediments to coordination)

Answer 3

1. firm mistakenly believes a competitor is changing one price when it is really charging another

• A firm may be able to observe the rival’s list price but not the effective price;

2. firm misunderstands the reasons for a competitor’s pricing decision or the own change in market share.

• A drop in the list price may be read as a price cut when effectively it may not be one

Question 4

What can a single and additional misread lead a firm to do?

(the Misread probelm)

Answer 4

will lead the firm to alternate between cooperative and non-cooperative moves.

Additional misreads can make the pattern of moves even worse.

Question 5

What is the effect of additional misreads?

Answer 5

Additional misreads can make the pattern of moves even worse.

Question 6

Which response might be better when there is a possibility of misreads?

Answer 6

Deferred response may be better than immediate response.

Question 7

When are orders considered “lumpy”?
Name industry examples!!
(2nd impediment to coordination)

Answer 7

• when sales occur relatively infrequently in large batches as opposed to being smoothly distributed over the year

Examples: airframe manufacturing, ship building

• The lag between orders makes the gain from price cutting more valuable relative to the cost imposed by the rival’s retaliation

Question 8

What happens to the frequency of competitive interactions when orders are lumpy?

(2nd impediments to coordination)

Answer 8

The frequency of competitive interactions is reduced.

Question 9

How does the lag between orders affect the gain from price cutting?

Answer 9

The lag between orders makes the gain from price cutting more valuable relative to the cost imposed by the rival’s retaliation.

Question 10

When can one easier detect deviations from cooperative pricing? Name example

–>Information availability regarding sales transaction –>(Impediments to coordination)

Answer 10

easier to detect when the transactions are public than when they are private

Example: transaction prices for gasoline sales are easily observable while they are not easily observable for automobile sales

Question 11

–>Information availability regarding sales transaction

When can one harder detect deviations from cooperative pricing? Name example

Answer 11

are harder to detect when the products are custom made than when they are standardized

Question 12

How do complex transactions affect the likelihood of misreading?

(Availability of information about sales transactions ->impediments to coordination)

Answer 12

Complex transactions may make misreadings more likely compared with simple transactions

Question 13

(Volatitiy of demand conditions 3thrd impediments to coodrination)

When is price cutting harder to detect?

Answer 13

• when demand conditions are volatile
• and the firm can observe only its own volume of sales

Question 14

(Volatitiy of demand conditions 3thrd impediments to coodrination)

In which situtation may a firm misread an situation to be an effort to steal busssines?

Answer 14

• Suppose one firm cuts its price in response to a decline in demand
• If other firms see the price cut but cannot detect their rival’s volume reduction, they may misread the situation as an effort to steal business

Question 15

What might happen if one firm cuts its price in response to a decline in demand?

(Volatility of demand)

Answer 15

• Other firms may see the price cut but cannot detect their rival’s volume reduction,
• leading them to misread the situation as an effort to steal business.

Question 16

(Volatitiy of demand conditions 3thrd impediments to coodrination)

What makes the coordination difficult? ( costs]

Answer 16

With large fixed costs, the monopoly price fluctuates a lot making coordination difficult

Question 17

Volatiliy of demand

What impact do large fixed costs have on monopoly pricing?

Answer 17

Large fixed costs cause the monopoly price to fluctuate a lot, making coordination difficult.

Question 18

What can be a focal point when firms are identical?

Answer 18

A single monopoly price.

Question 19

Why is it difficult for firms to coordinate pricing strategies?

(assymmetries among firms, sustianabiltiy of cooperative prices)

Answer 19

• Firms usually differ in costs, capacities, etc., which makes it difficult for them to coordinate pricing strategies to common objectives.

Question 20

Why might small firms have incentives to deviate from an agreement pricing strategy?

Answer 20

• Larger firms often have weak incentives to punish smaller price cutters
• Small firms might induce customers to buy their products by cutting prices.

Question 21

Coordination in practice

What factors help with coordination among competitors in a market?

Answer 21

• using round number price points
• maintaining even splits of the market shares
• Fewer identical products also make coordination easier
• established conventions and traditions can make rivals’ intentions transparent, aiding in coordination efforts

Question 22

Coordination in practice

When is coordination easier among products? (in terms of products

Answer 22

Coordination is easier with fewer products that are identical.

Question 23

Coordination in practice
When is coordination likely to be difficult? (Competitive environment)

Answer 23

in a competitive environments that are turbulent and rapidly changing

Question 24

(Coordination problem)

What does the folk theorem suggest about cooperative pricing?

Answer 24

• The folk theorem implies that cooperative pricing behavior is a possible outcome in an oligopolistic industry, even if all firms act unilaterally (self-interest)

Question 25

What is the coordination problem in achieving a desirable equilibrium?

Answer 25

Achieving a desirable equilibrium out of many possible equilibria is a coordination problem.

Question 26

What must each firm in an oligopolistic industry do according to the folk theorem?

(Coordination problem)

Answer 26

• Each firm must adopt the tit-for-tat strategy without explicit comm-unication that it intends to do so
• this must be a focal point — a strategy so compelling that a firm would expect all other firms to adopt it

Question 27

What is necessary for a cooperation-inducing strategy to be effective? (According to the folk theorem)

What is this focal point?

Answer 27

• The strategy must be a focal point
• a strategy so compelling that a firm would expect all other firms to adopt it

Question 28

What are certain markect structure conditions on which achieving a cooerpative pricing depends upon?

Answer 28

cooperative pricing may depend on following conditions

• concentration
• conditions that affect reaction speeds and detection lags
• asymmetries among firms
• price sensitivity of buyers

Question 29

Where is cooperative pricing more likely to happen? (Terms of market structure ?)

Answer 29

• In concentrated markets
• here revenue loss from a price cut is larger and the potential gain from new customers is smaller

Question 30

Why is cooperative pricing more likely in concentrated markets?

Answer 30

• Because the revenue loss from a price cut is larger and the potential gain from new customers is smaller.

Question 31

How can firms facilitate cooperative pricing?

Answer 31

through a number of practicess, including:

• Price leadership
• Advance announcement of price changes
• Most favored customer clauses
• Uniform delivered pricing

Question 32

What is price leadership? (A way too)

Answer 32

= is a way to overcome the problem of coordinating on a focal equilibrium

Question 33

What happens in price leadership? (What do firms give up)

Answer 33

• Each firm gives up its pricing autonomy and cedes control over industry pricing to a single firm

Question 34

How does the price leader influence the industry?

Name example of a low-price leader

Answer 34

• The price leader in the industry announces price changes ahead of others,
• and others match the leader’s price.

Example: low-price leader: Walmart

Question 35

When can the system of price leadership break down?

Answer 35

The system can break down if the leader does not retaliate if one of the follower firms defects

Question 36

What does advance announcement of price changes do?

Answer 36

It reduces the uncertainty that the rival will *undercut the firm

Question 37

What is another benefit of advance announcement of price changes?

Answer 37

It allows firms to roll back the changes if the rival deviates from cooperative pricing.

Question 38

hat is a most favored customer clause?

Answer 38

= is a provision in a sales contract that promises a buyer the lowest price the seller charges

Question 39

What are the two types of most favored customer policies mentioned?

Answer 39

• contemporaneous most favored customer policy; customer receives same terms and conditions at the same tiime
• retroactive most favored customer policy; customers receives most favorable deal that were offered to any customer retroactively

Question 40

How can most favored customer clauses inhibit/prevent (hindern) price competition?

Answer 40

• Most of them benefit the buyer ( a price cut to any customer lowers the price for the most favored customer),
• They discourage firms from cutting prices to other customers who do not have these clauses because a price cut to any customer lowers the price for the most favored customer

Question 41

What is uniform delivered pricing?

Answer 41

• A pricing method where transportation costs are included,
• facilitating cooperative pricing by making responses to price cutting more effective and deterrent.

Question 42

What are the two types of pricing when transportation costs are significant?

Answer 42

• Uniform FOB pricing
• uniform delivered pricing.

Question 43

Why is uniform delivered pricing effective in deterring defection from cooperative pricing?

Answer 43

Because the response to price cutting can be “surgical” and highly effective (

• any attempt competitors to undercut prices can be met with a precise and effective response since all customers pay the same price, it is easier for companies to react

Question 44

What affects the sustainability of cooperative pricing?

Answer 44

• market structure affects the sustainability of cooperative pricing
• thus, high market concentration facilitates cooperative pricing

Market structure: concentration, conditions that affect reaction speed and detection lags, asymmetries among firms, price sensitivity of buyers**

Question 45

What makes pricing cooperation more difficult?

Answer 45

• asymmetries among firms
• lumpy orders
• high buyer concentration
• secret sales transactions
• volatile demand

Question 46

Which practices facilitate cooperative pricing?

Answer 46

• price leadership
• advance announcements of price changes
• most favored customer clauses
• uniform delivered pricing

Question 47

Is high market concentration good for cooperative pricing?

Answer 47

Yes, high market concentration facilitates cooperative pricing