Price Discrimination and Game Theory (17/18)

best response

the choice that yields the highest payoff given the other player's choice

reservation price

the maximum price a customer will pay for a product = to marginal benefit

game theory

the science of making good decisions in situations where your best choice depends on someone else's choice

2nd mover advantage

the strategic advantage that can follow from taking an action that adapts to your rival's choices (flexibility)

firm-mover advantage

the strategic gain from an anticipatory action that can force a rival to respond less aggressively(you have to commit to being aggressive by taking credible, concrete action)

bundling works best when

those who get low MB from one part of bundle are same people who get high MB from other part of bundle

coordination game

when all players have a common interest in coordinating their choices, beneficial but difficult

quantity discounts

when the per-unit price is lower when you buy a larger quantity

multiple equilibria

when there is more than one equilibrium

anti-coordination games

when you best response is to take a different (but complementary) action to the other player, a good and bad equilibria exist

finitely repeated games

when you face same strategic interaction a fixed number of times

indefinitely repeated games

when you face the same strategic interaction an unknown number of times

repeated game

when you face the same strategic interaction with the same rivals and the same payoffs in successive periods

strategic interaction

when your best choice may depend on what others choose and their best choice may depend on what you choose

4 steps for making good strategic decisions

1) consider all possible outcomes 2) thing about "what ifs" separately 3) play your best response 4) put yourself in someone's shoes

how to segment market into groups

1) find groups whose demand differs 2) target your group discounts based on verifiable characteristics 3) base group discounts on difficult-to-change characteristics

conditions for price discrimination

1) your business has market power 2) you can prevent resale 3) you can target the right prices to the right customers

Nash equilibrium

An equilibrium in which the choice that each player makes is a best response to the choices other players are making

price discrimination

selling the same good at different prices

prisoner's dilemma

shows failure to cooperate, best outcome is not equilibrium outcome

game tree

shows how a game plays out over time, with the firm move forming the trunk, and then each subsequent choice branching out, so the final leaves show all possible outcomes

reason backward

start by analyzing the last period of the game. Use this to figure what will happen in the second to last period, and keep reasoning backward until you can see all the consequences from the decision

how to solve coordination problems

1) communication 2) focal points, culture and norms 3) laws and regulations

one-shot game

a strategic interaction that occurs only once

payoff table

a table listing you choices in each row, the other player's choices in each column and so shows all possible outcomes, listing the payoffs in each cell

bundling

alternate form of quantity discount, selling different goods together as a package (creates a hurdle to getting the second good at a lower price)

collusion

an agreement by rivals to not compete with each other, but to all charge high prices instead

self-interest leads to

bad outcomes, can make cooperation and coordination difficult

how price discrimination solves underproduction problem

by increasing quantity sold

successful price discrimination

charges high prices for customers who'll pay them and offers selective discounts to induce new customers to buy

perfect price discrimination

charging each customer their reservation price (results in charging highest price possible and making every possible sale)

Grim Trigger Strategy

if the other players have cooperated in all previous rounds, you will cooperate. If any player has defected in past, you will defect, punishes rivals for not cooperating

look forward

in games that play out over time, you should look forward to anticipate the likely consequences of your choices

hurdle method

offer lower prices to only those buyers who are willing to overcome some hurdle, or obstacle, useful when you don't know the groups reservation price

group pricing

price discrimination by charging different prices to different groups of people, divides one market into multiple for each group (set prices separately for each group)

check Mark method

put a check mark next to each player's best response, then an outcome with a check mark from both players is a Nash equilibrium

focal point

a cue from outside a game that helps you coordinate on a specific equilibrium

strategic plan

a list of instructions that describes exactly how to respond in any possible situation

prune the tree method

a method for solving game tress: start by looking forward to final period and highlighting out your rival's best responses, then prune the options the rival would never choose off your game tree