Definition
The Stackelberg Model is a strategic game theory in economics that describes a leader-follower model of market competition. In this scenario, one dominant firm, called the leader, sets its price or output first. Then, the remaining firms, known as followers, optimize their production and pricing decisions based on the leader’s actions.
Key Takeaways
- The Stackelberg Model is a leadership model in strategic economics where the leader firm moves first and the follower firms react accordingly. The movement order can grant a competitive advantage to the leader firm.
- This model suggests that the company that initially determines its market strategy has a significant strategic advantage and can potentially secure a larger market share. The follower firms can only manage to optimize their strategies based on the established market conditions.
- Additionally, the Stackelberg Model differs from the Cournot Model as it introduces the element of sequential play into the analysis of oligopoly. In this model, the entities do not decide simultaneously, but sequentially where a “leader” firm decides its output level first.
Importance
The Stackelberg Model is an essential concept in managerial economics and game theory, which illustrates a strategic interaction between firms within a market.
Its importance lies in its ability to describe a situation where one firm, called the leader, moves first and then the other firms, known as followers, adjust their strategies based on the leader’s actions.
This model helps in understanding the dynamics of market leadership, competition, and makes firms better equipped in making strategic decisions regarding price and output.
It gives the leader a competitive edge as they can control the market situation to their benefit.
Thus, the Stackelberg Model plays a crucial role in strategic planning and competitive business environment.
Explanation
The Stackelberg Model of competition is primarily used as a theoretical framework to analyze the strategic behavior of firms in an oligopolistic market. It is particularly useful in situations where firms don’t act simultaneously but sequentially, that is, one firm makes a move, followed by the second firm’s move considering the action of the first, and so on.
This concept was named after the German economist Heinrich Freiherr von Stackelberg who propounded this model. The main purpose of the Stackelberg Model is to provide insights into the dynamics of competition and depict the potential effects of the leadership in decision-making within an industry.
It serves as a useful tool that serves to enlighten us on how firms can maximize profits depending on their competitive positioning – as a market leader or a market follower. With the help of this model, firms can strategize and anticipate the reactions of their competitors, giving them an advantageous position in the highly competitive business environment.
Examples of Stackelberg Model
Airline Pricing Strategy: In the airline industry, the Stackelberg model is often used when setting flight prices. Larger airlines which have been in operation for a long time, like American Airlines or British Airways, often act as the leader in their routes. They set their prices first, and then smaller airlines, playing the role of followers, set their prices based on the leader’s. They often choose to match or slightly undercut the leader’s prices to attract price-sensitive travelers.
Gasoline Pricing: In the gas station industry, large networks of gas stations may act as price leaders, with smaller, independent gas stations acting as followers. The leader sets the price, and followers must decide whether to match or undercut these prices.
Telecommunications Industry: In some telecommunications markets, one large company often emerges as a market leader, setting their prices first. Other firms with less market power typically follow the prices that have been set by the larger company. For example, a company like AT&T might set their data plan prices and smaller companies might follow by setting similar or slightly lower prices.
FAQs about the Stackelberg Model
What is the Stackelberg Model?
The Stackelberg Model is an economic theory that describes how firms in an industry can enhance profits through strategic decision-making. It was named after the German economist Heinrich Freiherr von Stackelberg who first introduced it. The model assumes one firm, known as the leader, moves first and all other firms, known as followers, move sequentially after the leader.
What are the key assumption of the Stackelberg Model?
The Stackelberg Model assumes there is a dominant firm (the leader) which is first to make decisions on output levels or prices. Other firms in the industry (followers) react and adjust their own decisions based on the actions of the leader.
How does the Stackelberg Model work in practice?
The stackelberg model focuses on the situation where one firm has the opportunity to commit to a particular strategy before its competitors. The leader, having the advantage of making the first move, chooses output levels or prices that maximize its own profit, taking into account the followers’ reactions. The followers independently set their levels to maximize their own profits, given the leader’s decision.
What is the main difference between Cournot and Stackelberg competition?
The main difference between Cournot competition and Stackelberg competition is the order of moves. In Cournot competition, firms move simultaneously, whereas in Stackelberg competition, the leader firm moves first and followers adjust their strategies based on the leader’s decision.
What are some examples of Stackelberg competition in real markets?
Stackelberg competition is often observed in markets where firms have the ability to commit to their strategies before their competitors. This may include markets for new technological products, where a firm can become a market leader by being the first to release a product, as well as in some natural resource markets, where first-mover firms can influence market prices by adjusting their extraction rates.
Related Entrepreneurship Terms
- Leader-Follower Model
- Sequential Game
- Cournot Competition
- Quantity-setting Duopoly
- Subgame Perfection
Sources for More Information
- Investopedia – An extensive source that provides definitions of the Stackelberg Model along with examples and relevant terminology.
- Tutor2u – This site is also great for learning economic concepts like the Stackelberg Model, with simple and straightforward explanations.
- Encyclopedia Britannica – Provides a comprehensive and trustworthy explanation of the Stackelberg Model.
- Corporate Finance Institute (CFI) – Offers articles and training for financial professionals, including detailed explanations of the Stackelberg Model.
