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Week 14: Game Theory and Pricing Strategies Game Theory

This document discusses game theory, pricing strategies, and profit maximization. It covers the classifications of game theory including zero-sum, non-zero-sum, and cooperative games. Prisoner's dilemma is provided as a classic example of game theory. Pricing strategies like limit pricing, predatory pricing, and market penetration pricing are defined. Formulas for calculating markup on cost and price are presented, along with the optimal markup percentages based on price elasticity. Sample illustrations apply the pricing concepts and calculations.

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sherryl cao
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61 views

Week 14: Game Theory and Pricing Strategies Game Theory

This document discusses game theory, pricing strategies, and profit maximization. It covers the classifications of game theory including zero-sum, non-zero-sum, and cooperative games. Prisoner's dilemma is provided as a classic example of game theory. Pricing strategies like limit pricing, predatory pricing, and market penetration pricing are defined. Formulas for calculating markup on cost and price are presented, along with the optimal markup percentages based on price elasticity. Sample illustrations apply the pricing concepts and calculations.

Uploaded by

sherryl cao
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Week 14: Game Theory and Pricing Strategies

Game Theory

What is Game Theory?


Game theory is a general framework to help decision making when pay-offs depend on actions
taken by the others.
Game theory attempts to take into consideration the interactions between the participants and
their behavior to study the strategic decision-making between rational individuals. It tries to find out the
actions that a “player” should perform which would maximize his chances of success mathematically and
logically.

What are the classifications of Game Theory?

1. Zero-Sum Game -- One player gain is another player’s loss.


2. Non Zero-Sum Game -- There can be a net gain or net loss.
2a. Positive-Sum Game – Game for the potential mutual gain
2b. Negative-Sum Game – Game for the potential mutual loss
3. Cooperative Game – game in which the strategies of the participants are coordinated.

What is Prisoner’s Dilemma?


The classic prisoner’s dilemma game illustrates the difficulty of making decisions under
uncertainty, and shows how interdependence among decision makers can breed conflict.

Give sample illustration for Prisoner’s Dilemma


Pricing Strategies

What are the types of pricing strategies?

1. Limit Pricing – Strategy to set less then monopoly prices or maximum prices in an effort to deter market
entry by new and viable competitors.
2. Predatory Pricing – Pricing below marginal cost to knockout rivals and subsequently raising prices to
obtain monopoly profits.
3. Market penetration Pricing – Strategy of charging very low initial prices to create a new market or grab
market share.

What is nonprice competition?


Competitive technique tied to product quality, innovation and promotion among others.
Markup pricing and profit maximization

1. Markup on Cost- The difference between price and cost, measured relative to cost and expressed as a
percentage.
Formula:
Markup on cost = (P-MC)/MC

Where: P is Price
MC is marginal cost

2. Optimal Markup on cost- Profit maximizing markup on cost.


Formula:
Optimal Markup on cost = -1/(Price Elasticity + 1)

3. Markup on Price- The difference between price and cost measured relative to price and expressed as a
percentage.
Formula:
Markup on price = (P-MC)/P

4. Optimal Markup on Price- Profit maximizing markup on price


Formula:
Optimal Markup on price = (-1/Price Elasticity)

Sample Illustrations

1. Calculate for Mark upon cost and Mark upon price


Product Price($) Marginal Cost($) Mark upon cost(%) Mark upon Price(%)
A 2.00 0.75 167% 63%
B 4.00 2.00 100% 50%
C 6.00 3.00 100% 50%
D 8.00 4.50 78% 44%
E 10.00 5.50 82% 45%
F 12.00 6.50 85% 46%
G 14.00 7.50 87% 46%
H 16.00 9.00 78% 44%
I 18.00 10.00 80% 44%
J 20.00 15.00 33% 25%
K 22.00 18.00 22% 18%

2. Calculate for Optimal Mark upon cost and Optimal Mark upon price

Product Price Elasticity Optimal Mark upon cost(%) Optimal Mark upon Price(%)
A -1.50 200% 67%
B -2.00 100% 50%
C -2.50 67% 40%
D -4.00 33% 25%
E -5.00 25% 20%
F -10.00 11% 10%
G -15.00 7% 7%
H -20.00 5% 5%
I -25.00 4% 4%
J -50.00 2% 2%
K -60.00 2% 2%

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