spending, and lowering unit costs would all qualify as tough commitments.
Indeed, Fudenberg and Tirole characterize any of these moves as part of a “Top-
Dog” strategy, an aggressive strategy that induces the rival to back off. (Chapter 10
uses game theory to consider further instances that confer this kind of first-
mover advantage.) The extreme case of this strategy occurs if the firm’s first
move has such a dramatic effect on the economics of its rival that the rival’s best
response is to exit the market altogether. In effect, the top dog has driven its rival
from the market.
Interestingly, the logic of strategic commitment is exactly reversed when
the subsequent competition involves strategic complements. Consider once
again price competition. Here, a tough commitment that implies lower prices
by the initiating firm also induces lower prices by the competitor. But a lower
rival price is exactly what the first firm does not wantto happen. (The tough first
move would only make sense if it succeeded in driving the competitor out of
the market altogether.) Instead, the firm in question should adopt a “Fat-Cat”
strategy to use Fudenberg and Tirole’s label. This means making a softfirst
move, such as engaging in product differentiation—real (via product innova-
tion) or perceived (via increased advertising spending). The effect of any soft
move is to allow for a higher price for the firm itself and to induce a higher
price by the competitor. The point of the initial commitment is to soften or
blunt the subsequent price competition.
In summary, a tough strategic commitment is advantageous when the sub-
sequent competition involves strategic substitutes; a soft commitment is appro-
priate when strategic complements are involved.Advertising
For firms competing in an oligopoly, advertising can be a powerful means of
promoting sales. Indeed, firms that sell differentiated goods spend enormous
sums on advertising. We begin this section by analyzing a single firm’s optimal
advertising decision. Later, we consider advertising as a competitive weapon
within oligopoly.OPTIMAL ADVERTISING Consider a consumer-products firm that must deter-
mine not only the price at which to sell one of its goods but also the associated
level of advertising expenditure. At a given price, an increase in advertising
will raise sales to a greater or lesser extent.
One way to picture the firm’s decision problem is to write its demand func-
tion as Q(P, A). Here the demand function, Q, shows that the quantity of sales
depends on price, P, and advertising expenditure, A. The firm’s total profit in
terms of P and A can be written asP#Q(P, A)C[Q(P, A)]A. [9.6]
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