Module 5 - Game Theory and Pricing Strategy

Game Theory and
Pricing Strategy
INTRODUCTION
• As industry grows, the number of

firms operating within it also
reduces
• Structure of the market transitions
from competitive to oligopolistic
• The conduct of the market also
becomes more interdependent.
INTRO…
• this section provides insights in

making decisions under this type
of market [oligopolistic].
• These decisions are; pricing
strategy, entering/developing
markets, advertising strategy etc.
the basic tool to use for this;
• Game theory is the basic tool
Overview of the Games
and Strategic Thinking
Sample of Games
-Tic-Tac-To
- Poker
-checkers/dama
-Hawk-Dove (chicken)game
-Prisoners’ dilemma, etc.
Overview…
Game theory is actually a much

more general framework to aid in
decision making when your pay-
off depends on the actions taken
by the other player.
Terminologies…
Players- are participants or

individuals in a game which
make decisions
Strategies- these are the planned
decisions of the players
Payoff- the resulting benefit/revenue
given the actions or decisions
Terminologies…
The pay-off table or matrix
Strategy Left Right
Up 10,20 15,8
Down -10,7 10,10

Two General Types of Games
Simultaneous-Move, One-Shot Games
•Players must move/ make a decision at the

same time.
• Players must decide without the
knowledge of the decision made by the
other players
•One-shot means (the game is played
once)
Types of Games…
Sequential-Move,Games
•Players must move/ make a decision after

the opponent has made a move.
• Players must observe what the opponent
is doing and determine his course of action
given the move of the other
•E.g. Chess, checker, etc.
Types of Games…
Sequential-Move,Games
•Players must move/ make a decision after

the opponent has made a move.
• Players must observe what the opponent
is doing and determine his course of action
given the move of the other
•E.g. Chess, checker, etc.
Simultaneous-Move,
One-Shot Games
•The most relevant to mgr’l decision,

•Deciding without the knowledge of
other player is the essence of this
game.
• This is important to managers making
decisions in an environment of
interdependence
Simultaneous-Move…
Theoretical Scaffolds
We define the following;
• Strategy- a decision rule that describes the

actions of a player will take at each decision
point
• Normal-form game - a representation of
game indicating the players, their possible
strategies, and the payoff resulting from
alternative strategies.
Given (Figure 2);
Player B
Strategy Left Right
Up 10,20 15,8
Player A
Down -10,7 10,10
Questions??
• What are the strategies of each

player?
• What are the P/O for each player?
• What is the optimal/dominant
strategy of A or B?
Given (Figure 2);
Player B
Strategy Left Right
Up 10,20 15,8
Player A
Down -10,7 10,10
In a game-theoretic situation, it is
essential to know the Optimal
strategy.
Depending on the nature of the game,
we can characterize the optimum by
a situation involving a Dominant
strategy.
What is a dominant strategy??
Dominant strategy - a strategy that

results in the highest pay-off to a
player regardless of the opponents’
action
Given (Figure 2);
Player B
Strategy Left Right
Up 10,20 15,8
Player A
Down -10,7 10,10
In the game illustrated in Fig 2, the

dominant strategy for player A is UP!!
(pls. verify! Does B has a dominant
strategy?)
Principle:
“Always check if you have a dominant
strategy, if you have then play it!”
Given (Figure 2);
Player B
Strategy Left Right
Up 10,20 15,8
Player A
Down -10,7 10,10
In case a dominant strategy is

absent, the player plays a Secure
strategy; a strategy that
guarantees highest pay-off given
the worst possible scenario.
Principle:
“When playing; always put
yourself in your rivals shoes” If
you don’t have a dominant
strategy, see if your rival has,
then anticipate it!”
Given this situation, a very natural
way of formalizing the end result is
captured by Nash Equilibrium (Dr.
John Nash, 1994)
Nash Equilibrium- a condition describing
a set of strategies in which no player can
improve his/her payoff by unilaterally
changing his/her own strategy, given the
other player strategies.
Again we have the pay-off table;
(B)
Strategy Left Right
Up 10,20 15,8
(A)
Down -10,7 10,10
What are the NE strategies for
player A and B?
Answer: (UP/LEFT)…
Check using the P/O matrix above!!
Again we have the pay-off table;
(B)
Strategy Left Right
Up 10,20 15,8
(A)
Down -10,7 10,10
Application!!
1.Pricing decisions
2. Coordination decisions
3. Monitoring of employees
4. Advertising decision
Example:
(B)
Strategy Low Price High Price

Low Price 0,0 50-10
(A)
High Price -10,50 10,10
Required:
-Dom Strat
-N.E
Example:
(B)
Strategy Low Price High Price

Low Price 0,0 50-10
(A)
High Price -10,50 10,10
Answer:
- Both the Dominant and the
N.E. strategies are the
same.
Pricing Strategies for
Managerial Decisions
1. Pricing strategies for firms with

relative market power
a. Block pricing- is a pricing strategy in which

identical products are package together in
order to enhance profits by forcing
customers to make an all-or-none decision
to buy. This is designed to maximize the
consumers surplus to the customers.
Principle!!
-forces customers to make an all-or-none purchase

none decision.
b. Commodity bundling- The
practical way of bundling
several different products
together and selling them at a
single “bundled price”
e.g. -telephone and DSL internet

-airfare and hotel accommodation
-etc.
2. Pricing strategies for special cost
and demand structures.
a. Peak-load pricing - pricing strategy

which a higher prices are charged
during peak hours and /exam
during off-peak hours
Purpose:
To maximize profit
To allocate them and
Discriminate customers
a. Peak-load pricing
b. Cross-Subsidies- a pricing strategy in
which profit gained from the sale of
one product are used to subsidize
sales of a related product.
Example:
Adobe suite developer (PDF)
Acrobat reader- free
Adobe Acrobat-pay/for sale
To enjoy economies of scope

3. Price strategies in markets with
intense price competition
a.Price Matching - a strategy in which a

firm advertises a price and a promise to
match any lower price offered by
competitor.
This will tend to create a monopolistic

pricing service if all firm are offer same
price. Then it will just end up sharing the
market.
There are two cautions if we use this
strategy;
• Devise a truth revealing mechanism for

customer not to shirk.
• Cumbersome if competitors have lower

cost than your firm.
b. Inducing Brand Loyalty-stimulate
the customer to think that your
product is different than the other.
Example:
Frequent- flyer-buyer promo.

Comparative advertising
c.Randomized pricing- Pricing strategy
in which the firm intentionally varies its
price in an attempt to hide price info
from consumers and rivals.
Advantage:
• Reduces customer switching to other

products
• Reduces price cutting/ price wars
Disadvantage
•Costly
•Can work only if done on-line
through computer simulation
What do all these pricing
strategies say about the
traditional cost plus mark up
pricing approach??
Mechanics…
1. Determine the cost

AC=AVC+AFC
2. Determine the mark up over cost
Let X= Target profit in peso
Q= Number of units to be
produce
X/Q= Mark up
Therefore: P/unit=AVC + AFC + X/Q

Mechanics…
Then, if; P/unit=AVC + AFC + X/Q;
….and knowing that Q is uncertain,

then there goes the problem of
“Cost + Mark Up” pricing
strategy!!!
Thank You..

Module 5 - Game Theory and Pricing Strategy

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Module 5 - Game Theory and Pricing Strategy

Hochgeladen von

Copyright:

Verfügbare Formate

Game Theory and

• As industry grows, the number of

• this section provides insights in

Game theory is actually a much

Players- are participants or

The pay-off table or matrix

Strategy Left Right

Down -10,7 10,10

Simultaneous-Move, One-Shot Games

•Players must move/ make a decision at the

•Players must move/ make a decision after

•Players must move/ make a decision after

•The most relevant to mgr’l decision,

We define the following;

• Strategy- a decision rule that describes the

Given (Figure 2);

• What are the strategies of each

Given (Figure 2);

What is a dominant strategy??

Dominant strategy - a strategy that

Given (Figure 2);

In the game illustrated in Fig 2, the

Given (Figure 2);

In case a dominant strategy is

Strategy Left Right

Strategy Left Right

Strategy Low Price High Price

Strategy Low Price High Price

1. Pricing strategies for firms with

a. Block pricing- is a pricing strategy in which

-forces customers to make an all-or-none purchase

e.g. -telephone and DSL internet

a. Peak-load pricing - pricing strategy

To enjoy economies of scope

a.Price Matching - a strategy in which a

This will tend to create a monopolistic

• Devise a truth revealing mechanism for

• Cumbersome if competitors have lower

Frequent- flyer-buyer promo.

• Reduces customer switching to other

1. Determine the cost

Therefore: P/unit=AVC + AFC + X/Q

Then, if; P/unit=AVC + AFC + X/Q;

….and knowing that Q is uncertain,

Das könnte Ihnen auch gefallen