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Reciprocity, inequity-aversion, and oligopolistic competition

Santos-Pinto, Luís (2006): Reciprocity, inequity-aversion, and oligopolistic competition.

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Abstract

This paper extends the Cournot and Bertrand models of strategic interaction between firms by assuming that managers are not only profit maximizers, but also have preferences for reciprocity or are averse to inequity. A reciprocal manager responds to unkind behavior of rivals with unkind actions, while at the same time, it responds to kind behavior of rivals with kind actions. An inequity averse manager likes to reduce the difference between own profits and the rivals’ profits. The paper finds that if firms with reciprocal managers compete à la Cournot, then they may be able to sustain “collusive” outcomes under a constructive reciprocity equilibrium. By contrast, Stackelberg warfare may emerge under a destructive reciprocity equilibrium. If there is Cournot competition between firms and their managers are averse to advantageous (disadvantageous) inequity, then firms are better (worse) off than if managers only care about maximizing profits. If firms compete à la Bertrand, then only under very restrictive conditions will managers’ preferences for reciprocity or inequity aversion have an impact on equilibrium outcomes.

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