Neuroeconomic Interpretation of Oligopolistic

Dilemma
- Research Proposal-1 in Neuroeconomics by Chayasmita Deka, FPM IIM-A, 2017-18

Oligopolistic Dilemma in Real Life

‘Human beings are rational and acts rational’-this is one big claim we frequently make in economics.
But if we see our day to day business reports, we frequently come across firms making huge losses
and there are firms even exiting the industry due to unrecoverable losses. If human beings were to act
so rationally, shouldn’t these firms have always made profit? Why do we have firms bearing such
losses? Non-performing loans, market failures, stock market crash, negative returns of multinationals,
financial crisis. The list goes on. All such economic troubles raise the question- ‘Are human beings
really rational?’ Well-known fact is, humans’ exhibit bounded rationality. Where exactly rationality Commented [Office1]: That human beings are not
gets bounded is still not well explained. One such unexplained phenomenon is the ‘oligopolistic “rational” in the sense that ne0-classical economics thinks,
is now no longer in dispute. Neuroscience and behavioural
dilemma’. This dilemma mainly arises because an oligopolist cannot be sure what his rivals’ reaction research over the last 20 years has conclusively shown that
will be to various kinds of activities on his part. humans ALWAYS use a combination of reason and emotion
to come to and implement decisions (Loewenstein et. al.
The first big dilemma that oligopolist’ face is- the ‘prisoner’s dilemma’. It goes like this- suppose we 2001; Dolcos, Iordan and Dolcos 2011; Grabenhorst and
Rolls 2009; etc.).
have two prisoners. Both of them are separately taken to a room and asked to confess their crime. If
both of them confess, they both get a sentence of five years. If none of them confess, they both get a Bounded rationality as expounded by Simon (1957) is about
sentence of two years. If one of them confesses and the other doesn’t, then the one who confess gets a the limits of humans to their reasoning capacity. This also
follows directly from neuroscience and key brain operating
sentence of one year, the other who doesn’t get a sentence of ten years. The safer option for both is to
principles.
not confess and get a two year sentence. However if one of them opts to confess for their own benefit,
the other has to deal with a ten year sentence. Unless they know their rivals’ reaction, the dilemma
persists.

Another confusion arising out of the unpredictable pricing behaviour is the price war. Let us take the
case of Indian Telecom Industry, the second largest in the world after China. Predatory pricing has Commented [Office2]: What gets defined as predatory
always been haunting the profitability of this sector. These companies have always been trying to pricing depends on the regulator and the rules. One could
argue that telecom pricing in the US is actually price gouging
attract users with offers of freebies on recharge vouchers. After successive quarters of one firm the customer.
joining the other in this price war, the result was the key performance metric in Jan-March, the biggest
drop in a year. A look at our Indian Airline industry also reveals instances of price wars.

On 12th March 2014, a day just after rivals Spice Jet and Indigo ignited an aggressive price war
offering massive discounts on 60-90 days advanced bookings; Air India too joined the war offering
deep rebates on its festive sales. Following Air India’s move, Spice announced a ‘second chance’ sale
for its customers again their time for 30 days advanced booking on 15 th April. The result was obvious.
Spice Jet then reported a loss of Rs.559 crores and according to the Centre for Aviation, the airline
was expected to lose upto $35 million in Oct-Dec. A few weeks later, the Airlines even had to stall
their regular services due to unrecoverable losses.

The oligopolist decision makers have to be very alert in speculating their rivals’ pricing strategy. As
already exemplified, any wrong speculation can spell massive economic havoc. If the oligopolist
firms could predict the successive strategies of their rival firms, they would surely not have to see
such days of financial losses. The research idea on ‘Neuroeconomic Interpretation of Oligopolistic
Dilemma’ is a serious attempt in this direction.
Research Questions

What exactly goes on in the brain-deception/ambiguity when a person is about to take a strategic
action?
Which part of the brain becomes active in events of deception tendency or a tendency towards
ambiguity? Commented [Office3]: There is already literature that
How can a general interpretation of brain response remove the dilemma existing among oligopolist shows the neural substrates of ambiguity and risk, lying, etc.
and help them make informed decisions? Not sure though whether the substrates would remain the
same when the context is oligopolistic decision making by
the decision maker in the firm. In addition, what is less clear
is the translation of the perceive risk / ambiguity and the
Research Design level of deception into decisions one way or the other.

In my research I shall try to look into ‘the neuroeconomic interpretation of oligopolistic dilemma’.
‘Oligopolistic Dilemma’ can be operationalized into the psychological substrates of ‘risk’, ‘deception’
and ‘ambiguity’. The strategic behaviour would be studied by looking into the brain activity of the
selected subjects. The methodology to be followed in this exploratory research would be the
collection of primary data with fMRI as the main experimental tool. During the course of fMRI
experiment, a series of images of the brain would be acquired at a point of time when subjects would
be taking strategic pricing decisions under a purely experimental set up. Inferences regarding task
specific activation in brain would be made by measuring changes in brain signal between individual
images. fMRI data so obtained would then be plotted to get a HRF followed by statistical analysis of
fMRI data. Finally a brain mapping would be done to give an interpretation of their strategic
behaviour based on their brain activity.
The scan per subject would take around 20 minutes. The task to be displayed in the fMRI scanner
would be a game which I will design myself using Pebl software. It will be based purely on an
oligopolistic market situation which would be specific to the dilemma I want to interpret and the
substrates I want to measure. Regarding the experimental group, it will be a healthy group of 20
subjects, preferably 20 male and 20 female of age group 20-50 (age group doesn’t matter much).
Subjects belonging to any oligopolist firm would be preferred; however any other subjects with the Commented [Office4]: I disagree. Age and managerial
same attributes as those of the preferred group can also be accepted. All the subjects would be taught experience will influence the perception of risk / ambiguity
and deception.
the rules and regulations of the task and all necessary information would be provided. They would be
asked for their prior written consent to the experiment and they would be suitably compensated for
their time. This would be followed by the data acquisition and analysis of the data using the SPM
software.

Practical Implications of the Study

Subjects selected for this study would be people who are familiar with oligopolistic price and output
decisions. Attractive rewards would be offered to the subject who can emerge as the oligopolist
earning highest profit by outshining his competitors (here the fellow subjects). Such big incentives
and the pre-orientation given to the subjects prior to entering the fMRI for playing the oligopolist
strategic game shall create the similar environment which an oligopolist faces while making strategic
decisions. Thus a brain mapping of the subjects during that point of time can depict what exactly goes
on in the oligopolist brain while he is trying to outshine his rival in real scenario.

The creation of the game, game condition, proper rewards which instigate him to deceive and earn
more as well as the pre-orientation shall play an important role in the outcome of the experiment. If
these factors are well designed and the experiment well-implemented, an accurate interpretation of
oligopolistic dilemma can be made. Once the ‘next possible actions of the rivals’ can be interpreted,
the dilemma shall be resolved and losses pertaining to oligopolists due to wrong interpretation of
rival’s next moves can be prevented.
Commented [Office5]: I would also say that it may be
worth looking at a two period game to estimate decision
differences between a one shot Stackelberg (or
simultaneous – though I think, Stackelberg is closer to
reality). And to ask the question as to what kind of stimuli
lower the probability of price war behaviour and what are
the neural substrates of those stimuli.
(The study is under process and will be further improved upon as it’s moved further)

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