BUSI 620 Week 5 DB Forum 5 Example

Discussion Board Forum 5: Game Theory: Inside Oligopoly

BUSI 620 Global Economic Environment, Discussion Board Forum 5 (thread and 1 reply)

Thread by [Student Name]

The forum questions, the grocery example and the classmate's thread are composites standing in for the course's own; the research cited is real, and the requirements follow Liberty's public course guide for BUSI 620.

Thread

Chapter 10 of Baye and Prince (2017) treats pricing rivalry as a game. Consider two composite grocery chains in one metro area deciding each week whether to hold prices or run deep discounts. Profits, in thousands of dollars per week, are shown with Chain A's payoff first.

Whatever B does, A earns more by discounting (650 instead of 500, or 300 instead of 200), so discounting is a dominant strategy for both. The Nash equilibrium is both discounting, at 300 each, even though both holding would give each 500. This is the prisoner's dilemma.

The textbook's key result is that repetition can change this. If the game repeats indefinitely and the chains value future profits enough, each can adopt a trigger strategy: hold prices as long as the rival does, and discount forever after the rival cheats. Cheating gains 150 this week but loses 200 every week afterward, so cooperation pays when the future matters. The textbook expresses the condition through the interest rate: the lower the rate at which a firm discounts future profits, the more a stream of 200 a week in lost profit outweighs a one-time gain of 150, and the easier it is to hold prices.

Such cooperation is fragile, and history shows it. Porter (1983) studied the Joint Executive Committee, a railroad cartel that set grain shipping rates from Chicago to the East Coast in the 1880s. Using weekly data, he rejected the idea that price movements came only from changes in demand and cost and found evidence of switches between collusive and noncooperative periods. The price wars were not a failure of the theory; they were the punishment phase the theory predicts.

For managers, the lesson is about stability, not collusion, which is illegal. Markets with few firms, transparent prices and frequent interaction tend toward stable prices, while demand shocks, hidden discounts and new entrants make price wars more likely.

Reply to Jordan

Jordan, your thread argued that a regional airline can keep a low-cost carrier off its hub routes by announcing it will match any fare the entrant offers. Chapter 10 suggests testing that threat with backward induction (Baye & Prince, 2017). Suppose the entrant comes in anyway. At that point, the incumbent compares matching fares, a price war that costs it heavily on routes where it carries most of the passengers, with accommodating, sharing the route at somewhat lower fares. If accommodating is more profitable once entry has happened, the threat is not credible, and a forward-looking entrant will ignore it.

Threats become credible when the incumbent has already committed, for example by adding capacity that makes matching cheap. Another route to credibility is reputation. An incumbent that faces possible entrants on many routes may fight one entry at a loss to discourage the others, which turns a single game into a repeated one. That logic is weaker for a regional carrier with only a few hubs. Has your airline made any commitment like that, or is the threat only an announcement?

References

Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education.

Porter, R. H. (1983). A study of cartel stability: The Joint Executive Committee, 1880-1886. The Bell Journal of Economics, 14(2), 301-314. https://doi.org/10.2307/3003634