Consider a company A that produces a product that consumers are willing-to-pay a maximum price of $80 and it charges a price of $75. This company competes with company B which produces a substitute product that consumers are willing-to-pay a maximum price of $70. What is the maximum price that company B can charge?

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BlackTom AI · Accepted Answer

We start by restating the scenario to clarify what's being asked. Company A sells a product that customers are willing to pay up to $80 for, and it charges $75. Company B offers a substitute product with a maximum willingness-to-pay of $70 for customers. The question asks for the maximum price Company B can charge.

Option 1: $60. This price is below both the competitors' prices in the given context and well below B's own upper bound of $70. While charging $60 would likely attract price-sensitive customers and maintain demand in the presence of A’s $75 price, it is not the highest price at which B could still compete. It’s therefore not the maximum acceptable price.

Option 2: $65. Pricing at $65 keeps B undercutting A by $10 (A is $75). Since customers view B as a substitute, undercutting A by a meaningful margin helps ensure demand from price-sensitive buyers who would otherwise consider A. Given B’s substitute relationship and the difference in WTP (70 for B’s product vs. 80 for A’s), $65 can be the highest price that still reliably attracts enough turnout away from A to be profitable, balancing the trade-off between margin and demand.

Option 3: $55. This is a deeper undercut than necessary and reduces B’s margin further than needed. While it would still capture demand against A, it is not the maximum price B could charge. The aim is to identify the upper bound, not an unnecessarily low price.

Option 4: $70. This is the ceiling of B’s stated willingness-to-pay. In principle, charging $70 could maximize per-unit revenue while ensuring customers preferring B over A purchase B. However, in a competitive environment where A is priced at $75, some customers may still choose A due to perceived differences or brand affinity unless B’s value proposition fully matches or exceeds A’s; depending on the assumed substitutability and market response, $70 might not always be sustainable as the maximum price. In many textbook interpretations of this setup, the practical maximum under competition with A’s lower price and higher WTP is below $70, which aligns with selecting a price like $65 rather than the full $70.

Summing up, among the options, $65 represents the highest price that still undercuts A by a margin that sustains demand for B in the presence of A’s $75 price, without requiring B to price up to the full $70 (which may not be feasible in practice given substitution effects and relative product appeal).

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