Question

20. Read the attached excerpt from the Wall Street Journal and then answer the question found below it Last week's proposed settlement of a lawsuit against Visa Inc., Mastercard Inc., and bank credit card issuers o pens the way for millions of businesses to add checkout fees when customers play with plastic. Now, many businesses owners are wrestling with whether do so. to For the first time, doctors, retailers, bakeries and other merchants accepting ere dit cards will be able to recoup the so-called 'swipe fees' they incur each time they p credit card transaction. The swipe fees, which are b aren't visible to consumers. For decades, credit-card companies have merchants who accepted their cards from imposing a surcharge etween 1% and 3% of the purchase, on credit-card users. Luan Schooler, owner of Foster and Dobbs, a specialty food store in Port regon paid about $10,000 in swipe fees last year.....She said she would like to add a surcharge on purchases...to show customers the cost of using plastic.. But while most merchants say they generally would welcome the opportunity to expose the cost of swipe fees to the public, many don't want to run the risk of alienating credit card users..." [Wall Street Journal, July 19, 2012. YOUR JOB. I want you to look at Luan's situation as a game theory problem (where the rivals are Luan and some other competitor). I want you to construct a matrix that has a lominant strategy and a prisoner's dilemma. You make up the two strategies and the rofits in the matrix. Check your work.

Answer 1

Assume two Players are Luan (L) and Other Competitor (O)

There are two actions either to Add Surcharge (Represent it by A) on credit card users or Don’t Add Surcharge (Represent it by D) on credit card users

If both L & O Add Surcharge (i.e play A) the expenses of swipe charges will be paid by consumer hence the profits for both will increase by 2%

If both L & O Don’t Add Surcharge (i.e play D) the expenses of Swipe Charges will be borne by Players and there will be no change in profits. Payoffs will be 0% for both.

If player L Add Surcharge (i.e Play A) he will not have to bear the swipe charges but he will lose his market share. Hence will make extra losses of -5%. While player O is playing D he will have an extra market share and will make additional profit of 5%. Hence payoff of L,O when paying A,D will be -5%,5%.

If player O Add Surcharge (i.e Play A) he will not have to bear the swipe charges but he will lose his market share. Hence will make extra losses of -5%. While player L is playing D he will have an extra market share and will make additional profit of 5%. Hence payoff of L,O when paying D,A will be +5%,-5%.

Hence Payoff Matrix will be as follows:

Player Other Competitor (O) Add Surcharge (A)Don't Add Surcharge (D) +296, +296 +5%,-5% Player Luan (L) Add Surcharge (A) -5%, +5% 0%,0% Don't Add Surcharge (D)

Finding Dominant Strategies:

Now, Let’s analyse the response of player L. If O play A the possible payoff for L will be +2% for playing A and +5% for playing D, hence L will play D as payoff is higher. Similarly, if O play D the possible payoff for L will be -5% for playing A and 0% for playing D, hence L will play D as payoff is higher. Best Responses of L are shown in payoff matrix as Red Circle. We can see that Payer L is indifferent to player O as irrespective of what O is playing L is getting a better payoff if L plays D. Hence Not Adding Surcharge to Consumer by player Luan is a Dominant Strategy.

Player Other Competitor (O Add Surcharge (A) Don't Add Surcharge Add Surcharge (A) Don't Add Surcharge +296, +2% -5%, +5% Player Luan (L) 0% 596,

Now, Let’s analyse the response of player O. If L play A the possible payoff for O will be +2% for playing A and +5% for playing D, hence O will play D as payoff is higher. Similarly, if L play D the possible payoff for O will be -5% for playing A and 0% for playing D, hence O will play D as payoff is higher. Best Responses of O are shown in payoff matrix as Blue Square. We can see that Payer O is indifferent to player L as irrespective of what L is playing O is getting a better payoff if O plays D. Hence Not Adding Surcharge to Consumer by Other Competitor is a Dominant Strategy.

Player Other Competitor (O) Add Surcharge (A) Don't Add Surcharge Player Luan (L) Add Surcharge (A) +296, +2% +596, -320 Don't Add Surcharge

There is only one outcome were Best Responses intersect. Hence, there is one pure strategy Nash Equilibrium i.e D,D. So, both will Not Add Surcharge and there will be no change in their profits

It is similar to prisoner’s dilemma as they can simultaneously increase their payoff to +2%,+2% by choosing A,A but still they cannot add surcharge as there is always a chance that other player can deviate to not adding surcharge and get an additional profit of +5%. Same was the case in Prisoner's Dilemma where both Prisoner's could have improved their payoff by Denying but they both confess and get a lower payoff.