Edgeworth price cycle

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An Edgeworth price cycle is an asymmetric price variation that has the following characteristics:

  1. The good/service is a homogeneous commodity and customers are extremely price-sensitive. If one vendor undercuts another, they will capture all or a very large portion of the market (where "very large" means "as much as they can handle").
  2. Beginning from an equilibrium, one competitor will initiate a round of undercutting by pricing below the equilibrium. Because of (1), competitors will respond immediately, the same day if possible, with a match or a slight undercut.
  3. Undercutting will continue until they bid the price down to the wholesale cost.
  4. One competitor will then restore prices. Everyone will follow as quickly as possible, and the cycle repeats.

Because of (1), smaller competitors have a greater incentive to initiate cutting. Larger competitors will generally be the initiator of restorations. The cycle is asymmetric because restorations happen nearly simultaneously, but undercutting is generally slower.

Edgeworth cycles are distinguished from both sticky pricing and cost-based pricing. Sticky prices are typically found in markets with less aggressive price competition, so there are fewer or no cycles. Purely cost-based pricing occurs when retailers mark up from wholesale costs, so costs follow wholesale variations closely.

Competitive gasoline markets with a high degree of independent or small retailers typically demonstrate Edgeworth cycling, while markets dominated by majors (vertically integrated firms) will tend toward sticky pricing. Because the cycles tend to occur frequently, weekly average prices found in government reports will generally mask the cycling. Some studies have shown the restorations to occur on Tuesdays, with undercutting beginning within the next two days.

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References[edit]

  • E., Maskin and Tirole, J., “A Theory of Dynamic Oligopoly II: Price Competition, Kinked Demand Curves and Edgeworth Cycles”, Econometrica 56, 1988.
  • Eckert, Andrew and West, Douglas S., "Retail Gasoline Price Cycles across Spatially Dispersed Gasoline Stations", Journal of Law and Economics, Vol. XLVII, No. 1, April 2004, p. 245

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