Academic journal article Economic Inquiry

Satisficing and Prior-Free Optimality in Price Competition

Academic journal article Economic Inquiry

Satisficing and Prior-Free Optimality in Price Competition

Article excerpt

I. INTRODUCTION

The rational choice approach to market interaction investigates price competition maintaining commonly known unbounded rationality of sellers. Undoubtedly, to explain how the reasoning of competing sellers can result in a mutually optimal constellation of sales strategies via solving a fixed-point problem is an interesting and inspiring intellectual exercise. However, this exercise needs to be supplemented with studies that do not provide only "as if"-explanations, but try to more realistically capture how sellers may mentally represent sales competition and generate sales choices based on such mental representation.

Drawing on Simon's (1947, 1955) work (see also Selten 1998, which partly relies on Sauermann and Selten 1962), this paper models sellers' behavior using a bounded rationality approach based on aspiration levels. Profit maximizing is replaced by the goal of making "satisfactory" profits: sellers have aspiration levels concerning their profits and search for sales policies that guarantee these aspirations. (1) Because of the interdependence of sellers, it is reasonable to suppose that the profits a seller aims to achieve (or his profit aspirations) depend on what he expects from the others. Accordingly, the present analysis assumes that aspiration levels capture a seller's uncertainty about the others' behavior. The way in which this uncertainty is dealt with represents a key distinguishing feature of the model outlined here. (2) While the standard game theoretical approach to market interaction suggests that sellers share a common and correct conjecture about the others' actions, we allow sellers to entertain multiple conjectures. (3) Previous theoretical studies motivate why this assumption may be taken as valid. In particular, the so-called multiple prior models, proposed by Gilboa and Schmeidler (1989) and Bewley (2002) for one-person decision problems, generalize expected utility theory by assuming that the decision maker has a set of priors, rather than a single one. The premise of these models is that the "Bayesian" tenet according to which any uncertainty can and should be summarized by a single probability measure is too strong and represents an inaccurate description of people's behavior. (4) Applied to our context, this means that asking sellers to hold a unique conjecture about the price charged by the others may be unrealistic.

The theories of decision making without a precise prior allow a representation of beliefs by a set of probabilities, rather than by a single probability, but they still operate in an expected utility framework. (5) As opposed to these theories, we assume true uncertainty in a Knightian sense: no probability distribution is assigned to events (Knight 1985). The intuition behind this assumption is that even if boundedly rational people may not want to exclude the possibility that an event occurs, they may still be unable to specify how likely the event is. To emphasize that the approach we adopt is non-probabilistic, we prefer the word "conjecture" to "expectation" or "belief." We do not preclude the possibility that the set-valued conjecture contains only one element. We simply claim that if the set is not a singleton, then no probabilities need to be attached to its various elements. Thus, we regard the conjecture as prior free.

The main contribution of the present paper is to propose a theory that allows satisficing sellers to make "optimal" decisions without being equipped with any prior. Specifically, we consider an oligopoly where each seller chooses a unique price level and forms a set-valued prior-free conjecture about the average price charged by the remaining sellers. We do not model the process by which the conjecture is formed. Rather, we assume that the set-valued conjecture is idiosyncratically generated by each of the competing sellers, who furthermore form a profit aspiration for each element of the conjecture. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.