The Stackelberg leadership model introduces sequential decision-making in oligopoly markets. It explores how firms can gain advantages by moving first, anticipating competitors' reactions. This model highlights the importance of strategic thinking and commitment in competitive markets.

Firms acting as leaders can shape market outcomes by influencing followers' choices. The model uses game theory concepts like subgame perfect equilibrium and backward induction to analyze optimal strategies for both leaders and followers in various competitive scenarios.

Stackelberg Model Fundamentals

Leader-Follower Dynamics in Sequential Games

• Stackelberg competition describes a market structure where firms make decisions sequentially rather than simultaneously
• Leader-follower model captures the dynamic where one firm (the leader) moves first, and the other firm (the follower) observes the leader's action before making its own decision
• Sequential game structure allows the leader to anticipate the follower's reaction and incorporate this information into its decision-making process
• First-mover advantage refers to the strategic benefit the leader gains by committing to an action before the follower, potentially influencing the follower's choice (Coca-Cola entering a new market before Pepsi)
• Commitment is crucial in Stackelberg competition as the leader's initial action is binding and cannot be changed once the follower has made its decision (investing in a large production facility)

Strategic Implications and Applications

• Stackelberg model applies to various real-world scenarios, including market entry decisions, capacity investments, and product positioning
• Leader's optimal strategy involves anticipating and influencing the follower's reaction to maximize its own profits (setting a low price to deter entry)
• Follower's optimal response depends on the leader's action and its own best interests given the market conditions (choosing to focus on a different market segment)
• Stackelberg competition can lead to different market outcomes compared to simultaneous decision-making, such as higher prices or lower overall welfare (leader's aggressive output leading to reduced competition)
• Model's insights help firms make strategic decisions by considering the impact of their actions on competitors' responses (investing in a new technology to gain a competitive edge)

Equilibrium and Strategic Analysis

Subgame Perfect Equilibrium and Backward Induction

• Subgame perfect equilibrium (SPE) is the key solution concept in Stackelberg games, ensuring that the leader's and follower's strategies are optimal and credible at every decision point
• Backward induction is the process used to find the SPE by starting at the end of the game and working backwards, determining the optimal action for each player at each stage (follower's best response -> leader's optimal action)
• Reaction function represents the follower's best response to any given action by the leader, which is a crucial input in the backward induction process (follower's output as a function of leader's output)
• Credible threats are actions that the leader can take to influence the follower's behavior, but they must be feasible and rational for the leader to carry out (investing in excess capacity to deter entry)

Strategic Considerations and Practical Applications

• Equilibrium analysis in Stackelberg games helps firms understand the strategic implications of being a leader or follower in a market (first-mover advantage vs. flexibility of being a follower)
• Backward induction allows players to anticipate the actions of others and make decisions that are optimal given the expected future behavior (leader considering follower's best response when setting prices)
• Reaction functions provide valuable insights into how firms respond to each other's decisions, helping to predict market outcomes and plan strategic moves (follower's output increasing as leader's output decreases)
• Credible threats can be powerful tools for leaders to shape the competitive landscape, but they must be carefully evaluated to ensure they are feasible and effective (committing to a price war to deter entry)
• Managers can use the Stackelberg model to analyze real-world strategic situations, such as market entry, capacity investments, and product positioning, to make informed decisions and gain a competitive advantage (Apple launching a new product category before competitors)