Transcript Pricing in Imperfectly Competitive Markets

Pricing in Imperfectly
Competitive Markets
Determinants of Pricing
Decision
• Economic analysis of pricing in imperfectly
competitive markets identifies the following
elements of the market environment as
important to pricing decision:
– number of competitors/ease of entry
– similarity of competitors’ products
– capacity limitations
– on-going interactions
– Information on past pricing decisions
Bertrand
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Simultaneous price setting
Identical products
No capacity constraints
One time interaction
Price competition results in price equal
marginal cost for all firms and zero profits
Bertrand
• Bertrand paradox (p=mc even though few
firms in market) can be resolved by
relaxing certain assumptions:
• No Capacity Constraints
• Undifferentiated Products
• One-shot competition
Capacity Constraints
• Suppose each firm has max capacity of Ki
• If firm j sets a higher price than firm i, j
may get the left-over demand that firm i
can’t satisfy if demand exceeds i’s
capacity
• So setting price above MC may be
worthwhile
Repeated Games and Collusion
• Can Bertrand paradox be resolved if firms
interact repeatedly?
• Is it a Nash Equilibrium to set p>mc in the
first period of a repeated interaction in an
effort to ‘signal’ willingness to ‘cooperate’?
• Depends on what we mean by repeated?
-fixed number of times
-infinite number of times
• Fixed:
-last period is same as one-shot game
-no incentive to cooperate in any preceding
period
-cooperation unravels
• Infinite:
-no last period so cooperation is possible
-influence behaviour through use of
punishment strategies
• Cooperation more likely when:
-there is a high probability of future
interaction
-actions of rivals can be monitored
-defectors can be easily punished
-interest rates are low
Product differentiation
• Can Bertrand paradox be resolved if there
is a small number of firms that interact
strategically?
• Firms produce different varieties of a
product
-varieties differ according to some
characteristic
• Consumers differ as to how they value the
characteristic
• Consumer location on line reveals
preference for characteristic
• Consumer pays a ‘mismatch’ or
‘transportation’ cost t which measures their
aversion to buying something other than
their preferred degree of the characteristic
• This cost allows firms to charge a price
above marginal cost
• Product positioning:
• If price competition is intense:
-firms should locate far apart (differentiate),
in order to be able to drive up price
• If price competition is not intense:
-firms should locate close together—in the
center of the spectrum
Switching and Search Costs
• Once a consumer has experienced a
product, there may be a cost associated
with switching to a new product
• There may also be a cost associated with
finding out what products are available
and at what price
• In equilibrium, firms can have market
power if these costs are sufficiently high
Vertical Differentiation
• Consumers agree on what is better, but
differ in their willingness to pay for quality
• When firms compete in prices with given
qualities, equilibrium involves the higherquality firm charging a higher price than
the lower-quality firm and earning higher
profits
• If firms first choose quality first and then
price second, equlibrium involves
maximum differentiation.
• This is done in an effort to relax price
competition.
• True as long as consumers are sufficiently
different in their willingness to pay for
quality