Modeling Bounded Rationality in Capacity Allocation Games with the Quantal Response Equilibrium

Yefen Chen (), Xuanming Su () and Xiaobo Zhao ()
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Yefen Chen: Department of Industrial Engineering, Tsinghua University, Beijing 100084, China
Xuanming Su: The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Xiaobo Zhao: Department of Industrial Engineering, Tsinghua University, Beijing 100084, China

Management Science, 2012, vol. 58, issue 10, 1952-1962

Abstract: We consider a supply chain with a single supplier and two retailers. The retailers choose their orders strategically, and if their orders exceed the supplier's capacity, quantities are allocated proportionally to the orders. We experimentally study the capacity allocation game using subjects motivated by financial incentives. We find that the Nash equilibrium, which assumes that players are perfectly rational, substantially exaggerates retailers' tendency to strategically order more than they need. We propose a model of bounded rationality based on the quantal response equilibrium, in which players are not perfect optimizers and they face uncertainty in their opponents' actions. We structurally estimate model parameters using the maximum-likelihood method. Our results confirm that retailers exhibit bounded rationality, become more rational through repeated game play, but may not converge to perfect rationality as assumed by the Nash equilibrium. Finally, we consider several alternative behavioral theories and show that they do not explain our experimental data as well as our bounded rationality model. This paper was accepted by loana Popescu, guest editor, operations management.

Keywords: bounded rationality; capacity allocation; supply chain; quantal response equilibrium; Nash equilibrium (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (45)

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