Managerial Economics Jack Wu

Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now from price-based competition to marketing- based competition”, Andrew Conway, Morgan Stanley Coke vs. Pepsi, 1999

Competitive Dilemma What should Coke do?

Strategic Situations parties actively consider the interactions with one another in making decisions game theory -- set of ideas and principles to guide strategic thinking simultaneous actions: strategic form sequential actions: extensive form

Dominated Strategy generates worse consequences than another strategy, regardless of the choices of the other parties never use dominated strategy

Nash Equilibrium Given that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy No one is willing to deviate unilaterally from a Nash equilibrium

Solving for Nash Equilibrium eliminate dominated strategies, then check remaining cells “ arrow ” technique

Coke and Pepsi Game Nash equilibrium: for both parties, “raise price” is dominated by “discount”. but discounting is bad for both -- if only they could agree somehow to raise price. Coke and Pepsi stuck in this situation for four years until November 1999.

Radio Formats Merkur Lite ACno change Jupiter Hot ACJ: 60, M: 40 J: 60, M: 40 no changeJ: 70, M: 30 J: 50, M: 50

Radio Formats For Merkur, “Lite AC” is dominated by “no change”; so consider only “no change”, assuming Merkur chooses “no change”, Jupiter should choose “Hot AC”. Repeat using “arrow technique”.

Out of Nash Equilibrium What if another player doesn ’ t play Nash equilibrium strategy? Nash equilibrium strategy may not be best still don ’ t use dominated strategy

No Nash equilibrium in pure strategies Where to advertise?

Randomized Strategies choose among pure strategies according to probabilities must be unpredictable Example: retail market random discount Example: where to advertise _ We.com: ½ NBA and ½ NHL _ Competitor.com: ½ NBA and ½ NHL

Evening News:

Coordination and Competition Prime time for news is 8:0pm; second best is 7:30pm; since audience is limited, get maximum viewership if two channels schedule at different times. Question: which station gets 8:0pm? Situation has elements of coordination -- avoiding same time slot competition -- getting the 8:0pm slot

Zero/Positive Sum zero-sum games: pure competition -- one party better off only if other is worse off positive-sum games: coordination -- both can be better off or both worse off co-opetition: competition and coordination

Adopting Database Software Sol IBMOracle Venus IBMV: 1.5, S: 1.5 V: 1, S: 1 OracleV: 1, S: 1 V: 1.5, S: 1.5

Focal Point Nash equilibrium multiple Nash equilibria

Sequencing Game in extensive form – sequence of moves: nodes branches outcomes

Extensive Form: Equilibrium backward induction  final nodes  intermediate nodes  initial node

TVB ATV 4, 3 2.5, 2.5 1, 1 3, 4 8:00 7:30 8:00 7:30 8:00 TVB, ATV TV News: Sequential Moves

Strategic Move Action to influence beliefs or actions of other parties in a favorable way credibility – first mover advantage – second mover advantage

Examples Examples: Evening TV news -- both stations want to move first: which one can? Use strategic move, eg, contracts with advertisers to deliver news at 8pm. Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder. Issue: Is the move credible? Will it convince the other players? Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is enemy moving south or north? new product category -- let competitor test the market and educate the customers

consumer Litho Make prints Do not Buy Do not Make more prints Do not (1) serial number (2) destroying the plate (3) other solution? Lithographer

Conditional Strategic Moves threats promises

Morgan Stanley: “ Shareholder rights plan ” If any party acquires 15% or more of company ’ s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?

Shareholder Rights Plan This shareholder rights plan is a threat to potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder acquires more than 15%, then rights triggered, and bidder will be diluted. Nickname: poison pill. Actually works against shareholder rights -- by entrenching existing management.

Sharon Hilda acquires 100,000 shares doesn’t bid does not activates rights Hilda loses on initial stake + cost of takeover rises Poison Pill

Union Employer reject union demand accept do not strike Lose current wage and possibly gain in future wage Maintain current wage Why are strikes rare in American professional football? Strike

Answer Strike is a threat: must be credible, otherwise employer will not raise wage; for threat to be credible, expected gain from strike in future wage > loss of current wage. American professional sports: football -- players have very short careers; if they strike for one season, reduce professional careers by 20-25%. baseball -- long playing careers; strikes more common

depositor bank maintains deposit run Promise withdraws deposit remains solvent n.a. ?