Cognitive Hierarchy in Capacity Allocation Games

Tony Haitao Cui () and Yinghao Zhang ()
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Tony Haitao Cui: Carlson School of Management, University of Minnesota, Minneapolis, Minneapolis 55455
Yinghao Zhang: Carl H. Lindner College of Business, University of Cincinnati, Cincinnati, Ohio 45221

Management Science, 2018, vol. 64, issue 3, 1250-1270

Abstract: We examine a supply chain with a single supplier and multiple retailers to predict retailers’ actual ordering behaviors. If retailer orders exceed supplier capacity, a proportional rationing rule applies to capacity allocation among retailers. We propose a behavior model based on cognitive hierarchy theory, in which retailers with different levels of strategic-reasoning capabilities form heterogeneous beliefs about other players’ capabilities when choosing their orders. This behavioral model yields three interesting predictions. First, retailers’ orders increase as the number of retailers decreases or the supplier’s production capacity shrinks. Second, the orders tend to increase as the retailer population becomes more “sophisticated.” Third, retailers’ profits first increase in relation to their strategic-reasoning capabilities and then decrease, indicating an inverted U-shaped relationship between profits and strategic-reasoning capabilities. We experimentally examine the capacity allocation game with participants motivated by financial incentives. The experimental results and structural model estimation confirm the predictions of the behavioral model.

Keywords: capacity allocation; cognitive hierarchy; strategic thinking; behavioral operations management; behavioral economics (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (12)

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