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Unformatted text preview: ECON 696: Managerial Economics and Strategy Lecture Notes 8: The Dynamics of Pricing Rivalry The previous chapter discussed firms making strategic decisions and then competing tactically in markets characterized either by Cournot or Bertrand oligopolies. This chapter goes beyond this analysis to talk about multi-period dynamics in which firms make tactical decisions, other firms respond, and then the original firms have a chance to respond to their competitors' responses. The firms in an industry would ideally like to keep prices high and quantities low, but these conditions give individual firms incentives to undercut the others, selling a large quantity of merchandise at slightly lower prices and earning large profits. Sometimes, high prices in an industry can be maintained while other times they cannot, and we will discuss what factors help to determine this. The important difference between this chapter and the previous analysis is that in this chapter, each firm will have opportunities to change its tactical behavior. It will do this after considering: the solid knowledge it has about its own costs somewhat less solid knowledge about the price elasticity of demand for its own products and cross-price elasticities of demand between its own products and its competitors' products (that is, the degree to which they are substitutes) the likely responses of its competitors who, of course, are also doing this sort of analysis The Most Simple Model For a basic understanding of what we're talking about in this chapter, consider the diagram from p. 262. It describes the monopoly outcome in a market with constant marginal costs of $20. The monopolist will produce 40 units and sell them at a price of $60. If, instead, there are two firms in this market and each has constant marginal costs equal to $20, they will maximize their combined profits if they produce a total of 40 units and sell them at the price determined by the demand curve, $60. We can't predict how they will divide the market. It might seem reasonable that each firm would produce 20 units and just keep doing that forever. If representatives of the firms meet and discuss the matter (which is a crime in much of the world) they may come up with another division that is mutually beneficial. If the two firms cannot successfully keep the quantity sold at 40 and the price at $60 the quantity produced is likely to rise and the price to fall. In the worst case, they may reach the Bertrand equilibrium where the price is equal to the marginal cost of $20 and neither firm is making any profit. This might happen because the competitors can't decide how to divide the market or because, having reached an agreement (either explicitly or tacitly) one firm starts cheating, either producing more or cutting prices....
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This note was uploaded on 01/04/2012 for the course ECO 696 taught by Professor Staff during the Fall '11 term at Metropolitan NY.
- Fall '11