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Christopher Ruebeck, assistant professor of economics and business, gives the following account of how a game, Virtual Corporate Reality, helps his Industrial Organization students understand the concept of competition in the marketplace:

Students are often frustrated by textbook descriptions of competition — identical firms selling identical products at identical prices. It doesn’t take much of an empiricist to understand that the model does not explain much of the real world. What happens when we make more realistic assumptions? What happens when we account for different firms that compete through product characteristics and prices? What happens when firms act strategically, making their choices based on how they think their competitors may react? These are the guiding questions of Industrial Organization. To help student understand the complexities of such environments, they prepare by playing Virtual Corporate Reality (VCR).

Each student becomes part of a management team that jointly makes decisions about prices, new products, and strategic investment. The goal of VCR, as in the real world, is to make decisions that increase the firm’s value, calculated as cash on hand at the end of the game as well as the discounted value of the firm’s future profits.

Products in the hypothetical VCR market are differentiated in a single dimension: perhaps the sweetness of breakfast cereal, the location of a gas station, or the cut of a pair of jeans. As the game unfolds during the semester, teams consider how current decisions affect future profits. Team members, for example, must decide whether free cash flow should be invested in new production capacity or loaned out at interest; whether to cut prices to increase sales or maintain higher prices; whether to acquire the rights to produce a competitor’s product. The trick throughout is predicting the actions of other teams. Team members must grapple with the same questions real managers face: Will other teams introduce products similar to ours? Will they cut prices? Are they investing in new production capacity? The points that students are expected to take away from VCR are the importance of anticipating a rival’s actions and the consequences of a rival’s reaction to my actions.

Key Concepts
The key modeling concept of the game is that in raising its price a firm will not lose all its customers, which is the consequence of having differentiated my product from that of every other producer. Some customers will naturally gravitate toward Coca-Cola instead of Pepsi-Cola, others prefer Ford to Chevrolet. While raising the price will generate more revenue from loyal customers, lower prices will attract customers without strong attachments to a competitor’s product. Finding the right balance is a challenge.

The key theoretical concept is Nash equilibrium. Students may see Nash equilibria in other classes, but it is at the heart of modern Industrial Organization and is driven home in VCR. Rather than couching Nash’s equilibrium concept in equations and graphs, however, VCR allows students to see how a Nash equilibrium is attained in a competitive environment. Once a student sees how such an equilibrium is attained in a hypothetical market, he or she will have a greater appreciation for the equations and graphs presented in class.

Implementing VCR
VCR was originally developed at Johns Hopkins University. At Lafayette the game makes extensive use of the Blackboard web interface to report the results of each round. Currently, Muhammad (Rafat) Islam’05 and Katherine Wolchik’05 are developing a new web-based interface to replace the current version. These innovations will allow for more interactive use of the web and greater variations in the game, such as changes in customer loyalty, increasing potential market, and introduction of new products.

Categorized in: Academic News