Two gas stations next to each other set prices simultaneously. They both compete in price non-cooperatively (i.e., no tacit collusion). This pricing game is played once and then the world ends. We denote the price of gasoline per gallon station A and B charges as p_A and p_B, respectively. Suppose you are the manager of station A, and you observed the competitor (i.e., station B)'s sudden price decrease by 5 cents per gallon. Assuming no (tacit) collusion, what would be your best response to your competitor’s price decrease? Namely, what is your profit-maximizing behavior given station B has decreased its gas price per gallon?

Question

BlackTom AI · Accepted Answer

In a simple price competition with two identical products and no collusion, the other firm’s price change directly affects your best response, because consumers will buy from the cheaper station if prices are identical otherwise.
Option 1: Decrease the gas price. This is typically the rational response when a rival undercuts you or cuts its price; by lowering your price even slightly below Station B, you can capture the entire market (assuming identical costs and consumer sensitivity), which raises your quantity sold and can increase profit if the margin loss is offset by higher volume. The logic rests on the standard Bertrand/undercutting intuition: when prices are too close, the undercutting firm can steal market share.
Option 2: Increase the gas price. This would be suboptimal in the face of a rival’s price decrease. If you raise price while B has already cut its price, you risk losing customers to B and reducing volume, lowering profits unless you have a unique brand or location advantage that allows you to sustain higher prices. With homogeneous products and no collusion, there is little incentive to price above the undercutting rival.
Option 3: Do nothing. Standing pat after B lowers price typically leads to customers shifting entirely to B or at least reducing your market share, especially in a one-shot, competitive context with near-identical costs. By not responding, you forgo the opportunity to regain market share through a small price adjustment and may end up with a lower quantity and profit than if you had undercut.
In sum, the undercutting incentive drives the optimal response toward lowering your price to remain competitive and protect or improve market share, given the stated competitive setup and assumptions.

BU.220.620.81.FA25 Sample final exam (NOT for grade)- Requires Respondus LockDown Browser

View Explanation

Log in for full answers

Similar Questions

Bertrand duopolists, Firm 1 and Firm 2, face inverse market demand . Both have marginal cost, . The equilibrium price in the market will be

Assume that F1 and F2 can produce an identical product at a cost of 50 cents per unit. Each firm can produce only one unit and there is no collusion. The market consists of two buyers that consume one unit each and are willing to pay $1 for the product. What is the total value created and price?

What kind of competition is generally described as price competition?

Bertrand competition result is paradox because in the real world

is the wage offered by the firm. If a firm fails to hire the worker, its payoff is 0. Which game is most similar to the above hiring game in terms of strategic structure?

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler