(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 532
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CHAPTER 13 • Game Theory and Competitive Strategy 507
TABLE 13.12(a)
PRODUCTION CHOICE PROBLEM
Race Car Motors
Far Out Engines
Small cars
Big cars
Small engines
3, 6
3, 0
Big engines
1, 1
8, 3
Suppose Far Out threatens to produce big engines no matter what Race Car
does; suppose, too, that no other engine producer can easily satisfy the needs
of Race Car. If Race Car believed Far Out’s threat, it would produce big cars:
Otherwise, it would have trouble finding engines for its small cars and would
earn only $1 million instead of $3 million. But the threat is not credible: Once
Race Car responded by announcing its intentions to produce small cars, Far Out
would have no incentive to carry out its threat.
Far Out can make its threat credible by visibly and irreversibly reducing
some of its own payoffs in the matrix, thereby constraining its own choices. In
particular, Far Out must reduce its profits from small engines (the payoffs in the
top row of the matrix). It might do this by shutting down or destroying some of its
small engine production capacity. This would result in the payoff matrix shown in
Table 13.12(b). Now Race Car knows that whatever kind of car it produces, Far
Out will produce big engines. If Race Car produces the small cars, Far Out will
sell the big engines as best it can to other car producers and settle for making
only $1 million. But this is better than making no profits by producing small
engines. Because Race Car will have to look elsewhere for engines, its profit will
also be lower ($1 million). Now it is clearly in Race Car’s interest to produce
large cars. By taking an action that seemingly puts itself at a disadvantage, Far Out
has improved its outcome in the game.
Although strategic commitments of this kind can be effective, they are risky
and depend heavily on having accurate knowledge of the payoff matrix and the
industry. Suppose, for example, that Far Out commits itself to producing big
engines but is surprised to find that another firm can produce small engines at
a low cost. The commitment may then lead Far Out to bankruptcy rather than
continued high profits.
THE ROLE OF REPUTATION Developing the right kind of reputation can also
give one a strategic advantage. Again, consider Far Out Engines’ desire to produce big engines for Race Car Motors’ big cars. Suppose that the managers of
Far Out Engines develop a reputation for being irrational—perhaps downright
crazy. They threaten to produce big engines no matter what Race Car Motors
TABLE 13.12(b)
MODIFIED PRODUCTION CHOICE PROBLEM
Race Car Motors
Far Out Engines
Small cars
Big cars
Small engines
0, 6
0, 0
Big engines
1, 1
8, 3
