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The Dynamics of Pricing Rivalry

A. Tony Prasetiantono Week 10

Dynamic Pricing Rivalry
• In real-world markets, firms that compete with one another do so over time, again and again. • This implies that competitive moves that might have short-run benefits may, in the longer run, hurt the firm once its competitors have had time to make countermoves of their own.

“Pricing Cooperation” (1)
• Pricing cooperation is harder to achieve under some market structures than others, partly because under certain conditions, firms cannot coordinate on a focal equilibrium, and partly because market structure conditions. • Market structure conditions that may facilitate or complicate the attainment of cooperative and competitive stability.

“Pricing Cooperation” (2)
• Market concentration • Structural conditions that affect reaction speeds and detection lags • Asymmetric among firms • Price sensitivity of buyers

Firms Asymmetries (1)
• When firms are different from each other— asymmetric—even the expectation that competitors will instantly match a price cut may not deter certain firms from cutting prices aggressively. • Fare war in the US airline industry: Northwest Airlines vs. American Airlines. • The 1992 fare war was the most vicious price war that hit the US airline industry. • It deepened the already record losses the airline industry was suffering in the wake of the recession that began with the Persian Gulf crisis in 1990.

Firms Asymmetries (2)
• When firms are asymmetric, they will have different views about how high the price in the industry ought to be. • Northwest has a poor route system, an inferior frequent flier program, and a reputation for poor service. • Principal competitors: American and United had better route structures and frequent flier programs.

Firms Asymmetries (3)
• Under these conditions, Northwest’s best hope was probably to move the industry down the market demand curve through deep price cuts.

Cournot Equilibrium
• One of the first models of oligopoly markets was developed by Augustin Cournot (1835). • At the Cournot equilibrium, each firm is choosing its profit-maximizing output, given the output produced by the other firm. • In other words, each firm selects a quantity to produce, and the resulting total output determines the market price.

Bertrand Price Competition
• Joseph Bertrand (1883) introduced that each firm selects a price to maximize its own profits, given the price that it believes the other firm will select. • Each firm also believes that its pricing practices will not affect the pricing of its rival; each firm views its rival’s price as fixed.

Pricing Discipline in the US Cigarette Industry (1)
• Cigarettes are one of the most highly concentrated industries in the American economy, with a four-firm concentration ratio of 93 percent in 1992. • Such pricing discipline helped the industry raise prices by 14 percent per year (198085), a rate far above inflation. • The result was one of the most profitable business in the American economy.

• As the smallest and least profitable of the big six cigarette producers, Liggett had the least to gain from raising prices. When the grocery store cooperative Topco approached Ligett in 1980 with a plan to market and sell discount cigarettes at prices 30 percent below branded cigarettes, Ligett was receptive.

Pricing Discipline in the US Cigarette Industry (2)

Pricing Discipline in the US Cigarette Industry (3)
• The initial success of the discount cigarettes surprised even Liggett. • By 1984, its share of overall cigarette sales had tripled, largely by virtue of its success in the discount cigarette business.

• Airline Industries: state-owned enterprises (Garuda, Merpati) vs. private-owned enterprises (Lion, Adam) • Soccer World Cup (live broadcasted license): RCTI (2002) vs. SCTV (2006) • Movie distributor: Subentra Group (21) vs. competitors

Discussion: Firms Asymmetries in Indonesia