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Welcome back from the in-video quiz.
And we've just looked at aggressive commitment as one enabler of cooperation.
Let's now have a look at another type of commitment which
we call cooperative or soft commitment,
and see how that can help cooperation.
So how does cooperative commitment work?
Well, one way to build cooperation or to enable
cooperation by being soft or being cooperative is through building a reputation.
Simply building a reputation of being a reliable competitor or
cooperator and making it known that you treat others
fairly can be one way of building your reputation,
therefore enabling cooperation one way or another.
So that sends two signals.
First of all, you're making your type of behavior more predictable to your competitors,
which is one issue.
The other issue is if you've built up a reputation,
it's going to mean that it's going to be more expensive or it's going to be
costly for you to behave in
an uncooperative way because you're losing that reputation very quickly.
And in one way or another,
this is a similar mechanism to what's called a self-binding commitment.
A self-binding commitment is basically about making an investment that convinces
potential partners or competitors that one is committed to act cooperatively.
So, in other words,
you are eliminating the moves which would lead to competitive equilibria.
And so one way for example would be that if you know that
a certain type of behavior would trigger a response by your competitor,
you can commit not to engage in that kind of behavior.
Right? So, if that means that you cannot choose that kind of behavior,
it also means that there cannot be a response or there will
not be a response by your competitor,
and therefore the market will be less competitive overall.
Now, another interesting aspect or
another interesting mechanism that works as
a soft commitment is the so-called most favored customer clause.
It's a provision in sales contracts that you can
write which basically promises the customer that
it will get refunded if another customer is charged a lower price sometime in the future.
Most of the time, these most favored customer clauses will have some time limit to it,
usually six months or one year,
and that means that if within
that time period the price of a particular product ever goes down,
you're going to be refunded the difference between the price you
paid and the price that someone else pays at a later point.
Now, again, it sends two signals.
The first one is to the consumer.
There's no point in waiting until the prices go down because if you buy now,
then even if half a year later the prices go down,
you're going to pay the lower price. That's the issue.
That's the point of the most favored customer clause.
But on the other hand, you're also sending a signal to your competitors.
You're sending the signal that it will be costly for you to compete for certain customers
because lowering prices will not just lower your margin for future customers,
but you're also going to have to reimburse
all the previous customers that you sold to at a higher price.
So that means that, relatively speaking,
it's going to be more costly for you to lower your price,
which is exactly the kind of cooperative commitment or
soft commitment that we often think about.
So, to sum up from the last two videos,
we found that commitment can help firms to coordinate their behavior.
There are two types of commitment with quite different underlying mechanisms.
We have aggressive commitments that are all about moving first,
eliminating those moves that can lead to unattractive equilibria.
On the other hand, cooperative commitment is all about
signaling to other players that you're a friendly,
nice guy and you're committed to behaving cooperatively.
So for now, thanks very much for staying on throughout the whole lecture.
We're almost done for today,
but before we go on,
let's finally wrap up what we've learned today in the next video.
So I'll see you in a second in the wrap-up.
Tobias KretschmerProfessor
