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