Econ Ch 9
1. What is the difference between a soft commitment and no commitment?
In making no commitment, a firm has not taken an action or made an investment that alters its own and/or its rival’s competitive responses. In contrast, a soft commitment is one that, no matter what its competitors do, the firm will behave less aggressively than if it had not made the commitment. Thus, in a Cournot game a soft commitment will cause the firm to produce relatively less output, while in a Bertrand game a soft commitment will induce the firm to charge a higher price than if it had not made the commitment.
2. How are commitments related to sunk costs?
A commitment is a difficult-to-reverse action or investment that alters the subsequent competitive interaction between a firm and its rivals, presumably to the advantage of the firm making the commitment. A sunk cost is a cost that has already been incurred and cannot be recovered. In order for an action or investment to serve as a commitment, rival firms must believe the firm who made the investment will, indeed, alter their future behavior. The key to the credibility of the firm’s strategic commitment is irreversibility. If a firm could recover the cost of its strategic commitment after it was set in motion, much credibility would be lost. Therefore, the higher the proportion of an investment that is sunk, the more likely that investment would serve as a strategic commitment.
3. Explain why prices are usually strategic complements and capacities are usually strategic substitutes.
If an increase (decrease) in a particular action on the part of one firm is met by an increase (decrease) in the same action on the part of another firm, than the actions are said to be strategic complements. If two firms sell identical products and one firm lowers its price, the other firm will lose many of its customers. Most likely, a firm can partially restore profits by responding to the price cut of its rival by a price cut of its own.
In making no commitment, a firm has not taken an action or made an investment that alters its own and/or its rival’s competitive responses. In contrast, a soft commitment is one that, no matter what its competitors do, the firm will behave less aggressively than if it had not made the commitment. Thus, in a Cournot game a soft commitment will cause the firm to produce relatively less output, while in a Bertrand game a soft commitment will induce the firm to charge a higher price than if it had not made the commitment.
2. How are commitments related to sunk costs?
A commitment is a difficult-to-reverse action or investment that alters the subsequent competitive interaction between a firm and its rivals, presumably to the advantage of the firm making the commitment. A sunk cost is a cost that has already been incurred and cannot be recovered. In order for an action or investment to serve as a commitment, rival firms must believe the firm who made the investment will, indeed, alter their future behavior. The key to the credibility of the firm’s strategic commitment is irreversibility. If a firm could recover the cost of its strategic commitment after it was set in motion, much credibility would be lost. Therefore, the higher the proportion of an investment that is sunk, the more likely that investment would serve as a strategic commitment.
3. Explain why prices are usually strategic complements and capacities are usually strategic substitutes.
If an increase (decrease) in a particular action on the part of one firm is met by an increase (decrease) in the same action on the part of another firm, than the actions are said to be strategic complements. If two firms sell identical products and one firm lowers its price, the other firm will lose many of its customers. Most likely, a firm can partially restore profits by responding to the price cut of its rival by a price cut of its own.