The Gas Station GameYou and your partners own a neighborhood gasoline station. It is lucrative enoughthat you can hire people to handle the everyday business at the station. You andyour partners merely have to act as supervisors. Not a bad deal. It is a franchisestation, though, so you don’t have a completely free hand in running things. At thesame time, you and your partners make most of the major decisions.Your nearest competitor is a station right across the street. Your station and theirsget most of the business in the area. Some people in the neighborhood are veryloyal to you and your station: They only buy your gasoline and they depend onyour mechanics to repair their cars. They have almost no regard for prices orother changes in the environment. They are wonderful, true-blue customers.Most people in the neighborhood, however, are price conscious:They always go the station that is selling for less. As a result, both you and theother station make sure to display your prices clearly. You always notice eachother’s prices. Most of the time, your prices are exactly the same. Prof. Tirupati Misra@ibslko
They are a franchise station, too. This means that you are both limited in howquickly you can change prices. If you want to cut prices (to get more business),you must first get the approval of your parent company. The same is true for yourcompetitor. As it happens, the company bureaucracies are so slow that you areboth stuck with a price for at least a week before you can change it.If one station makes a change and sells for a lower price, and the other doesn’t,the station with the lower price gets a lot more business. Whoever’s price is higheralways responds by also reducing their price, but it takes them a week to getapproval. In the meantime, many customers go to the lower priced station.You and the owners of the other station are aware of these delays. You also knowthat either of you can make a killing – for a short time – if you cut your price andthe other station doesn’t. but cutting your price can be risky.Your profit picture looks like this: If both station keep identical prices, each of youwill make about $1200 profit per week. If you cut your price and the other stationdoesn’t, your profits will go up to $1600 (because of increased sales), and theywill only make $400. (If we assume relatively constant sales in the neighborhood,the total of the two station’s profits goes down, since one station has cut theirprice and, therefore, their profit margin.) Prof. Tirupati Misra@ibslko
The opposite is also true: If they cut their price and you don’t, their profits will be$1600 and you will only earn $400. If both of you happen to cut your prices at thesame time, you’ll each make only &800: All of your customers will be happy withthe lower prices but they will choose between the two stations indiscriminately,and you and the other station will earn less since you’ve cut your prices.Both you and the other station realize the folly of cutting prices (this is anassumption that is not always true, as will see later); if anyone cuts their price for ashort time, you will both raise prices soon afterwards to regain lost profits. Thetemptation to cut your price for a short-term gain, however, is always there.We will assume for this exercise that readjustment will follow your choices. Thegains you make will still add up when it comes time to calculate your total profits,but each of your choices will lead to one of the same four outcomes, as depictedin the following Profit Table. Prof. Tirupati Misra@ibslko
We will begin with you and the other station making a secret, simultaneouschoice to keep your prices the Same, or Cut your prices. When everyone hasmade their choice, I will display your outcomes on the board. I’ll only do thatwhen everyone’s choices are in; you can change your choice anytime yourchoice anytime until I put them up on the board. After they are displayed, wewill assume, for simplicity sake, that the system recycles. This means that, foryour next choice, you will be facing the exact same outcome possibilities. Youwill Cut your price or leave it the Same; the other station will too; and one of thefour outcomes pairs in the Table will result.Your main concern is profits. You’re in business to make money and more isbetter than less. This sounds simple enough. But what it also means is that youshould not be concerned about how the other station does. Whether they dowell or badly should be no concern of yours – unless it affects your profits. Youshould simply do as well as you can to boost you profits as must as you can. Prof. Tirupati Misra@ibslko
You and the other station will make a series of choices. Each time you willeither Cut our price or leave it the Same. They will make a similar decision.When you make your decision, let me know without letting the other stationknow what you have chosen. I’ll display everyone’s choices each time youchoose a price. Then we’ll go on to your next choice. The Gas Station Game Profit Table They Keep Constant Cut Prices Keep Constant $1200, $1200 $400, $1600 You Cut Prices $1600, $400 $800, $800The first number in each pair refers to the profits that you would receive; thesecond refers to the profits that the other station would receive. When youboth keep your prices constant, you both earn $1600; the station remainingconstant will earn $400. if both stations cut their prices, they both will earnonly $800. Prof. Tirupati Misra@ibslko
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