Conjectural variation

3 key takeaways

• Conjectural variation measures the degree to which firms anticipate and factor in the reactions of competitors when making strategic decisions in an industry.
• Positive conjectural variation implies that firms expect rivals to match or mimic their actions, leading to competitive pricing behavior and limited deviations from equilibrium.
• Negative conjectural variation indicates that firms anticipate rivals to counteract their actions, resulting in strategic interactions characterized by aggressive competition and deviations from market equilibrium.

What is Conjectural Variation?

Conjectural variation refers to the perception or expectation that firms in an industry have regarding how their competitors will respond to changes in their own behavior. It captures the strategic interdependence among firms operating in a market, where each firm’s actions are influenced not only by market demand and cost considerations but also by expectations of how rivals will adjust their strategies. Conjectural variation influences pricing decisions, output levels, market conduct, and competitive dynamics within an industry, shaping the outcomes of strategic interactions among firms.

Importance of Conjectural Variation

• Strategic Decision-Making: Conjectural variation influences firms’ strategic decision-making processes by shaping their expectations of how competitors will react to changes in market conditions, pricing strategies, or product offerings.
• Market Conduct: Understanding conjectural variation helps firms anticipate and respond to competitive threats, opportunities, and market dynamics, enabling them to adapt their strategies to achieve their business objectives.
• Competition Policy: Conjectural variation is a key consideration in competition policy and antitrust analysis, as it provides insights into market structure, conduct, and performance, helping regulators assess the competitive effects of firms’ behavior and market outcomes.

How Conjectural Variation Works

Positive Conjectural Variation

• Collusive Behavior: Positive conjectural variation implies that firms expect rivals to cooperate or collude by matching or mimicking their actions, leading to stable pricing behavior and limited deviations from market equilibrium.
• Price Leadership: In industries with positive conjectural variation, a dominant firm or market leader may exercise price leadership, setting prices that competitors follow to maintain market stability and avoid price wars.

Negative Conjectural Variation

• Competitive Behavior: Negative conjectural variation suggests that firms anticipate rivals to counteract their actions by adjusting prices, output levels, or marketing strategies, leading to aggressive competition and deviations from market equilibrium.
• Price Wars: Industries with negative conjectural variation may experience price wars, where firms engage in aggressive price competition to gain market share, increase sales, or drive out competitors.

Equilibrium Conditions

• Nash Equilibrium: Conjectural variation influences the equilibrium outcomes of strategic interactions among firms, affecting market prices, quantities, and profits under different competitive scenarios.
• Cournot Equilibrium: In oligopolistic markets, conjectural variation is a key determinant of the Cournot equilibrium, where firms simultaneously choose output levels based on their expectations of rivals’ responses.

Examples of Conjectural Variation

• Automobile Industry: In the automobile industry, firms may have positive conjectural variation, where pricing decisions are influenced by the expectation that competitors will match price changes to maintain market stability.
• Airline Industry: The airline industry often exhibits negative conjectural variation, as airlines anticipate rivals to react aggressively to changes in fares or route expansions, leading to intense price competition and capacity adjustments.
• Technology Sector: In the technology sector, conjectural variation may vary depending on the level of innovation, market concentration, and competitive dynamics, influencing firms’ strategic responses to product launches, pricing strategies, and technological advancements.

Real-world Application

• Strategic Pricing: Firms use conjectural variation to inform their pricing strategies, forecasting how competitors will react to changes in prices, promotions, or discounts to maximize revenue and market share.
• Market Entry and Expansion: Understanding conjectural variation helps firms assess competitive threats and opportunities when entering new markets or expanding existing operations, enabling them to develop effective market entry strategies.
• Competition Policy: Regulators and policymakers consider conjectural variation when evaluating market competitiveness, antitrust issues, and merger reviews to ensure that firms’ behavior does not harm consumer welfare or distort competition within industries.