Question

From the 4 Fudenberg and Tirole (FT) strategic commitment strategy scenarios. Can some one explain with examples Which strategic commitments lead to positive strategic effects? I dont want the explanantion of all4 models, just the justification which models will lead to positive strategic effect and why?

Answer 1

Basically, the "fat-cat effect" is one of four phenomena predicted by game theorists in supply-demand economics. It happens in a "duopoly" scenario, when two firms compete in a market, and are jockeying to increase their market share over the other, or else simply to increase profit for both of them tacitly.

The Fat Cat Effect, simply, is when Firm 1, the "incumbent" in an industry defending against a smaller adversary, increases their prices and sees a benefit not only to themselves but the other firm as well. This is counter-intuitive; in competition with another firm, you'd logically want to charge as low a price as you could afford to sell your product for.

However, doing so (known as the "puppy dog ploy") will encourage an aggressive response by your competitor, who will try to further undercut you. The competition between your firms becomes solely price-based, and it will hurt both companies in the long-term as options for the firms to reinvest in technology and product/process improvements become limited compared to any other firms in the industry that aren't at each other's throats.

By contrast, increasing the price of a quality product increases the implied value of that product to consumers, who will demand your product even at the higher price, because of the perceived higher quality. In addition, your competitor can raise their own prices to pad their bottom line, giving a net benefit to both companies' bottom lines, increasing investment potential.

The other two strategies involve the demand curve based on changes in quantity supplied. The more quantity is supplied, the less is demanded. Therefore, a "Top Dog" strategy of producing more of your product than your competitor to "flood the market" will make more money for you due to increased volume, even as prices decrease. Your competitor will sell fewer items, and make less on each of them, suffering a double-whammy. By contrast, looking "lean and hungry" by producing less than before gives the initiative to your competitor; regardless of demand and price, you've handed market dominance to your competitor. So, you should avoid commitments that make it difficult to stay ahead of your competitor in production.