Strategic complements

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In economics and game theory, the decisions of two or more players are called strategic complements if they mutually reinforce one another, and they are called strategic substitutes if they mutually offset one another. These terms were originally coined by Bulow, Geanakoplos, and Klemperer (1985).[1]

To see what is meant by 'reinforce' or 'offset', consider a situation in which the players all have similar choices to make, as in the paper of Bulow et al., where the players are all imperfectly competitive firms that must each decide how much to produce. Then the production decisions are strategic complements if an increase in the production of one firm increases the marginal revenues of the others, because that gives the others an incentive to produce more too. This tends to be the case if there are sufficiently strong aggregate increasing returns to scale and/or the demand curves for the firms' products have a sufficiently low own-price elasticity. On the other hand, the production decisions are strategic substitutes if an increase in one firm's output decreases the marginal revenues of the others, giving them an incentive to produce less.

According to Russell Cooper and Andrew John, strategic complementarity is the basic property underlying examples of multiple equilibria in coordination games.[2]

Calculus formulationEdit

Mathematically, consider a symmetric game with two players that each have payoff function  , where   represents the player's own decision, and   represents the decision of the other player. Assume   is increasing and concave in the player's own strategy  . Under these assumptions, the two decisions are strategic complements if an increase in each player's own decision   raises the marginal payoff   of the other player. In other words, the decisions are strategic complements if the second derivative   is positive for  . Equivalently, this means that the function   is supermodular.

On the other hand, the decisions are strategic substitutes if   is negative, that is, if   is submodular.


ExampleEdit

In their original paper, Bulow et al. use a simple model of competition between two firms to illustrate their ideas. The revenue for firm x with production rates   is given by

 

while the revenue for firm y with production rate   in market 2 is given by

 

At any interior equilibrium,  , we must have

 

Using vector calculus, geometric algebra, or differential geometry, Bulow et al. showed that the sensitivity of the Cournot equilibrium to changes in   can be calculated in terms of second partial derivatives of the payoff functions:

 

When  ,

 

This, as price is increased in market 1, Firm x sells more in market 1 and less in market 2, while firm y sells more in market 2. If the Cournot equilibrium of this model is calculated explicitly, we find

 

See alsoEdit

ReferencesEdit

  1. ^ J. Bulow, J. Geanakoplos, and P. Klemperer (1985), 'Multimarket oligopoly: strategic substitutes and strategic complements'. Journal of Political Economy 93, pp. 488-511,https://www.jstor.org/stable/1832005 .
  2. ^ Russell Cooper and Andrew John (1988), 'Coordinating coordination failures in Keynesian models.' Quarterly Journal of Economics 103 (3), pp. 441-63.