COMPLEXITY CONSIDERATIONS AND MARKET BEHAVIOR

The article is concerned with market behavior when firms have limited ability to handle effectively the complexity of changing market condit ions and strategic interaction. Modelling the managerial bounded ratio nality by using the concept of strategic complexity as measured by a f inite automaton, we show that market behavior can be considerably alte red once there is a limit on the complexity of strategies. In particul ar, we demonstrate that when an incumbent firm operates in several mar kets, and entry to one market may induce the incumbent to exit from an other market (divestiture) in order to ''concentrate'' on the competit ion it faces. For different parameters the incumbent may react to such an entry by exit from the same market, creating specialization. We al so demonstrate that bounded complexity can serve as an entry barrier, giving an advantage to the established incumbent firm.