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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.

Suggested Citation

  • Chaim Fershtman & Ehud Kalai, 1993. "Complexity Considerations and Market Behavior," RAND Journal of Economics, The RAND Corporation, vol. 24(2), pages 224-235, Summer.
    • Handle: RePEc:rje:randje:v:24:y:1993:i:summer:p:224-235
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    Cited by:

    1. Jones, Matthew T., 2014. "Strategic complexity and cooperation: An experimental study," Journal of Economic Behavior & Organization, Elsevier, vol. 106(C), pages 352-366.
    2. Diego Aparicio & Roberto Rigobon, 2020. "Quantum Prices," NBER Working Papers 26646, National Bureau of Economic Research, Inc.
    3. van Damme, E.E.C., 1995. "Game theory : The next stage," Other publications TiSEM 7779b0f9-bef5-45c7-ae6b-7, Tilburg University, School of Economics and Management.
    4. Oz Shy & Rune Stenbacka, 2005. "Partial outsourcing, monitoring cost, and market structure," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 38(4), pages 1173-1190, November.
    5. Shy, Oz & Stenbacka, Rune, 2012. "Efficient organization of production: Nested versus horizontal outsourcing," Economics Letters, Elsevier, vol. 116(3), pages 593-596.
    6. Fishman, Arthur & Simhon, Avi, 2002. "The Division of Labor, Inequality and Growth," Journal of Economic Growth, Springer, vol. 7(2), pages 117-136, June.
    7. Aparicio, Diego & Rigobon, Roberto, 2023. "Quantum prices," Journal of International Economics, Elsevier, vol. 143(C).
    8. Ehud Kalai, 1995. "Games," Discussion Papers 1141, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    9. Matsusaka, John G. & Nanda, Vikram, 2002. "Internal Capital Markets and Corporate Refocusing," Journal of Financial Intermediation, Elsevier, vol. 11(2), pages 176-211, April.
    10. 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.
    11. O. Emre Ergungor, 2002. "Community banks as small business lenders: the tough road ahead," Working Papers (Old Series) 0203, Federal Reserve Bank of Cleveland.
    12. Hurkens, Sjaak & Vulkan, Nir, 2001. "Information acquisition and entry," Journal of Economic Behavior & Organization, Elsevier, vol. 44(4), pages 467-479, April.
    13. B. Luppi, 2006. "Price Competition over Boundedly Rational Agents," Working Papers 565, Dipartimento Scienze Economiche, Universita' di Bologna.
    14. Mitchell Berlin, 1999. "Jack of all trades? Product diversification in nonfinancial firms," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 15-29.
    15. Hvide, Hans K., 2002. "Pragmatic beliefs and overconfidence," Journal of Economic Behavior & Organization, Elsevier, vol. 48(1), pages 15-28, May.

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