Business Economics (A)
Researcher training course
7-8th week
Yuji Honjo
Faculty of Commerce
Chuo University
Contents

Theme


Keyword
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
The Dynamics of Pricing Rivalry
Static vs. Dynamic, Cooperative pricing, Tit-forTat Pricing, Fork Theorem
Discussions
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
Explain the case when cooperative pricing occurs.
What factors affect cooperative pricing?
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Case: Australian Newspaper
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Fairfax vs. News Limited
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Fairfax

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
Morning Herald (Morning)
<= more affluent readership
Sun (Evening)
News Limited (Rupert Murdoch)


Daily Telegraph (Morning)
Daily Miller (Evening)
3
(Continued)
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Evening newspaper (market)
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Price competition: 1941-1974
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
The price increase was announced by the Sun, was
matched within days by the Daily Mirror.
Price competition: 1975


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Sun <= price leader
Sun: 10 cents => 12 cents
Daily Mirror: 10 cents => keep the price
Price competition: 1979
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Sun: 12 cents => 10 cents
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Dynamic Pricing Rivalry

Why the Cournot and Bertrand Models Are
Not Dynamic

These two models => Not dynamic but static
(Figure 8.1)
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Dynamic Pricing Rivalry

Dynamic Pricing Rivalry: Intention
(Figure 8.2.)
Monopoly outcome => profits: $16 million =>
Each profits: $8 million
 Bertrand outcome => Each profits: $0
=> The monopoly outcome is better for each firm.

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Cooperative Pricing

Cooperative Pricing
Cf. Price collusion => felony
 Situations in which firms can sustain prices in
excess of those that would arise in a noncooperative single-shot price or quantity-setting
game
=> Is cooperative pricing achievable when firms
make pricing decisions non-cooperatively?
7
(Continued)

Which
If the firm lowers the price
=> Short-term increase in profits
=> The firm’s rival might respond by lowering the
price.

See Chamberlin (1922).
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Competitor Responses and Tit-forTat Pricing
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e.g. Shell vs. Exxon Mobil
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Bertrand price => $20
Monopoly price => $60
Shell: $20 => $60
Exxon Mobil: $20 => $40
Exxon Mobil’s profits: $12 million
=> The profits exceeds $8 million (monopoly level).

9
(Continued)

Shell’s Strategies
1.
2.
3.
Raise its price to $60.
If Exxon Mobil sticks with the low price ($40),
Shell drops its price to $40.
If Exxon Mobil follows Shell, both the firms
earn higher profits.
10
(Continued)

Exxon Mobil’s Strategies
(1) Sticks with the current price of $40,
or (2) follow Shell and raise its price to $60.
(1) Price $40
Profits
(2) Price $60
Profits
$40
$40
$40
$40
(Total: $57.93 million)
$60
$60
$60
$60
(Total: $77.05 million)
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(Continued)

Exxon Mobil’s profits
(1) Profits < (2) Profits
=> Exxon Mobil gain more profit by matching
Shell’s price.
 Tit-for-tat strategy
e.g. Fairfax & Sons vs. Daily Mirror
=> × Tit-for-tat strategy
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Tit-for-Tat Pricing with Many Firms

Extension of the Shell-Exxon Mobil example
πM: Industry’s profit when all firms charge the
monopoly price.
 π0: Profit at the prevailing price (< πM)
(1) π0 + π0/Ni
(2) πM/N + πM/Ni
 Cooperative outcome
(1) < (2) => We obtain Equation (8.1).

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Fork Theorem

Cooperative Outcome
If the discount rate i is not too large, then the
cooperative outcome will be sustainable.
=> Fork theorem


Coordinating on an Equilibrium
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Achieving a particular equilibrium in a game with
many equilibrium, some potentially are more
attractive than others. => Coordination problem
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Why Is Tit-for-Tat So Compelling?
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Is Tit-for-Tat the only strategy?
=> No
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Grim Trigger Strategy
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If any firm deviates from the cooperating price,
the others will drop its price to marginal cost in
the next period and keep it there forever.
Tit-for-Tat Strategy

Niceness, provocability, and forgiveness
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Misreads
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Misread
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A firm mistakenly believes a competitor is charging one
price when it is really charging another
A firm misunderstands the reasons for a competitor’s
pricing decision
Dixit and Nalebuff’s (1991) argument

When misreads are possible, pricing strategies that are
less provocable and more forgiving than tit-for-tat are
desirable.
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How Market Structure Affects the Sustainability of
Cooperative Pricing
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Cooperative Pricing

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Market concentration
Structural conditions that affect reaction speeds
and detection lags
Asymmetries among firms
Price sensitivity of buyers
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Market Concentration and the Sustainability of
Cooperative Pricing
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Market Concentration
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The benefit-cost ratio in equation (8.1) goes up as
the number of firms goes down.
The more concentrated the market, the larger the
benefits from cooperation.
Coordinating on a particular focal strategy is
likely to be easier for less firms there are compete
against one another in the market.
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Reaction Speed, Detection Lags, and the
Sustainability of Cooperative Pricing

Reaction Speed
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If price cuts can be matched instantly, cooperative pricing
will always be sustainable.
A firm may be unable to react quickly to its
competitors’ pricing moves because of

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
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Lags in detecting competitors’ price
Infrequently interactions with competitors
Ambiguous in identifying which firm among a group of
firms in a market is cutting price
Difficulties distinguishing drops in volume due to price
cutting by rivals from drops in volume due to
unanticipated decreases in market demand
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(Continued)
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Important factors
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Lumpiness of orders
Information about sales transactions
The number of buyers
Volatility of demand and cost conditions
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Asymmetries among Firms and the Sustainability
of Cooperative Pricing

Asymmetries among Firms
Firms are not identical
=> Firms have different costs.
=> No single focal price
=> Cooperative pricing – difficult

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Two related reasons for the difficulty
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Large firms benefit more from the move toward
cooperative pricing than does small firms.
Small firms anticipate that large firms have weak
incentives to punish a small firm that undercuts its price.
21
Case: Dot Matrix Printer in South
Africa

Epson vs. Panasonic



Epson – Leader firm
Panasonic: 5% discount => Capture a fraction α
of demand
By allowing Panasonic to sell printers at a lower
price than it charges, Epson would be extending a
price umbrella.
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Market Structure and the Sustainability of
Cooperative Pricing
(See Table 8.1.)
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Facilitating Practices
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Firms themselves can facilitate cooperative
pricing by
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Price leadership
Advance announcement of price charges
Most favored customer clauses
Uniform delivered pricing
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