the gas station game

1. The Gas Station Game
You and your partners own a neighborhood gasoline station. It is lucrative enough
that you can hire people to handle the everyday business at the station. You and
your partners merely have to act as supervisors. Not a bad deal. It is a franchise
station, though, so you don’t have a completely free hand in running things. At the
same time, you and your partners make most of the major decisions.
Your nearest competitor is a station right across the street. Your station and theirs
get most of the business in the area. Some people in the neighborhood are very
loyal to you and your station: They only buy your gasoline and they depend on
your mechanics to repair their cars. They have almost no regard for prices or
other 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 the
other station make sure to display your prices clearly. You always notice each
other’s prices. Most of the time, your prices are exactly the same.
Prof. Tirupati Misra@ibslko

2. They are a franchise station, too. This means that you are both limited in how
quickly 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 your
competitor. As it happens, the company bureaucracies are so slow that you are
both 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 higher
always responds by also reducing their price, but it takes them a week to get
approval. 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 know
that either of you can make a killing – for a short time – if you cut your price and
the 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 you
will make about $1200 profit per week. If you cut your price and the other station
doesn’t, your profits will go up to $1600 (because of increased sales), and they
will 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 their
price and, therefore, their profit margin.)
Prof. Tirupati Misra@ibslko

3. 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 the
same time, you’ll each make only &800: All of your customers will be happy with
the 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 an
assumption that is not always true, as will see later); if anyone cuts their price for a
short time, you will both raise prices soon afterwards to regain lost profits. The
temptation 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. The
gains 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 depicted
in the following Profit Table.
Prof. Tirupati Misra@ibslko

4. We will begin with you and the other station making a secret, simultaneous
choice to keep your prices the Same, or Cut your prices. When everyone has
made their choice, I will display your outcomes on the board. I’ll only do that
when everyone’s choices are in; you can change your choice anytime your
choice anytime until I put them up on the board. After they are displayed, we
will assume, for simplicity sake, that the system recycles. This means that, for
your next choice, you will be facing the exact same outcome possibilities. You
will Cut your price or leave it the Same; the other station will too; and one of the
four outcomes pairs in the Table will result.
Your main concern is profits. You’re in business to make money and more is
better than less. This sounds simple enough. But what it also means is that you
should not be concerned about how the other station does. Whether they do
well or badly should be no concern of yours – unless it affects your profits. You
should simply do as well as you can to boost you profits as must as you can.
Prof. Tirupati Misra@ibslko

5. You and the other station will make a series of choices. Each time you will
either 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 station
know what you have chosen. I’ll display everyone’s choices each time you
choose 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, $800
The first number in each pair refers to the profits that you would receive; the
second refers to the profits that the other station would receive. When you
both keep your prices constant, you both earn $1600; the station remaining
constant will earn $400. if both stations cut their prices, they both will earn
only $800.
Prof. Tirupati Misra@ibslko