(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 531
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506 PART 3 • Market Structure and Competitive Strategy
TABLE 13.11
PRICING OF COMPUTERS AND WORD
PROCESSORS
Firm 2
Firm 1
High price
Low price
High price
100, 80
80, 100
Low price
20, 0
10, 20
Empty Threats
Suppose Firm 1 produces personal computers that can be used both as word
processors and to do other tasks. Firm 2 produces only dedicated word processors. As the payoff matrix in Table 13.11 shows, as long as Firm 1 charges a high
price for its computers, both firms can make a good deal of money. Even if Firm
2 charges a low price for its word processors, many people will still buy Firm 1’s
computers (because they can do so many other things), although some buyers
will be induced by the price differential to buy the dedicated word processor
instead. However, if Firm 1 charges a low price, Firm 2 will also have to charge
a low price (or else make zero profit), and the profit of both firms will be significantly reduced.
Firm 1 would prefer the outcome in the upper left-hand corner of the matrix.
For Firm 2, however, charging a low price is clearly a dominant strategy. Thus
the outcome in the upper right-hand corner will prevail (no matter which firm
sets its price first).
Firm 1 would probably be viewed as the “dominant” firm in this industry
because its pricing actions will have the greatest impact on overall industry
profits. Can Firm 1 induce Firm 2 to charge a high price by threatening to charge
a low price if Firm 2 charges a low price? No, as the payoff matrix in Table 13.11
makes clear: Whatever Firm 2 does, Firm 1 will be much worse off if it charges a
low price. As a result, its threat is not credible.
Commitment and Credibility
Sometimes firms can make threats credible. To see how, consider the following
example. Race Car Motors, Inc., produces cars, and Far Out Engines, Ltd., produces specialty car engines. Far Out Engines sells most of its engines to Race Car
Motors, and a few to a limited outside market. Nonetheless, it depends heavily
on Race Car Motors and makes its production decisions in response to Race
Car’s production plans.
We thus have a sequential game in which Race Car is the “leader.” It will
decide what kind of cars to build, and Far Out Engines will then decide what
kind of engines to produce. The payoff matrix in Table 13.12(a) shows the possible outcomes of this game. (Profits are in millions of dollars.) Observe that Race
Car will do best by deciding to produce small cars. It knows that in response to
this decision, Far Out will produce small engines, most of which Race Car will
then buy. As a result, Far Out will make $3 million and Race Car $6 million.
Far Out, however, would much prefer the outcome in the lower right-hand
corner of the payoff matrix. If it could produce big engines, and if Race Car produced big cars and thus bought the big engines, it would make $8 million. (Race
Car, however, would make only $3 million.) Can Far Out induce Race Car to
produce big cars instead of small ones?
