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Complexity Considerations and Market Behavior

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  • Chaim Fershtman
  • Ehud Kalai

Abstract

The article is concerned with market behavior when firms have limited ability to handle effectively the complexity of changing market conditions and strategic interaction . Modelling the managerial bounded rationality by using the concept of strategic complexity as measured by a finite automation, we show that market behavior can be considerably altered once there is a limit on the complexity of strategies. In particular, we demonstrate that when an incumbent firm operates in several markets, an entry to one market may induce the incumbent to exit from another market (divestiture) in order to "concentrate" on the competition it faces. For different parameters the incumbent may react to such an entry by exit from the same market, creating specialization. We also demonstrate that bounded complexity can serve as an entry barrier, giving an advantage to the established incumbent firm.

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 24 (1993)
Issue (Month): 2 (Summer)
Pages: 224-235

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Handle: RePEc:rje:randje:v:24:y:1993:i:summer:p:224-235

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Cited by:
  1. Oz Shy & Rune Stenbacka, 2009. "Efficient organization of production: nested versus horizontal outsourcing," Working Papers 09-9, Federal Reserve Bank of Boston.
  2. Mitchell Berlin, 1999. "Jack of all trades? Product diversification in nonfinancial firms," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 15-29.
  3. Hurkens, Sjaak & Vulkan, Nir, 2001. "Information acquisition and entry," Journal of Economic Behavior & Organization, Elsevier, vol. 44(4), pages 467-479, April.
  4. Horaguchi, Haruo, 1996. "The role of information processing cost as the foundation of bounded rationality in game theory," Economics Letters, Elsevier, vol. 51(3), pages 287-294, June.
  5. B. Luppi, 2006. "Price Competition over Boundedly Rational Agents," Working Papers 565, Dipartimento Scienze Economiche, Universita' di Bologna.
  6. Hvide, Hans K., 2002. "Pragmatic beliefs and overconfidence," Journal of Economic Behavior & Organization, Elsevier, vol. 48(1), pages 15-28, May.
  7. Matsusaka, John G. & Nanda, Vikram, 2002. "Internal Capital Markets and Corporate Refocusing," Journal of Financial Intermediation, Elsevier, vol. 11(2), pages 176-211, April.
  8. O. Emre Ergungor, 2002. "Community banks as small business lenders: the tough road ahead," Working Paper 0203, Federal Reserve Bank of Cleveland.
  9. Ehud Kalai, 1995. "Games," Discussion Papers 1141, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

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