Managerial Economics & Business Strategy 8th Edition by Michael Baye,Jeff Prince

Exercise 6

While there is a degree of differentiation among general merchandise retailers like Target and Kmart, weekly newspaper circulars announcing sales provide evidence that these firms engage in price competition. This suggests that Target and Kmart simultaneously choose to announce one of two prices for a given product: a regular price or a sale price. Suppose that when one firm announces the sale price and the other announces the regular price for a particular product, the firm announcing the sale price attracts 50 million extra customers to earn a profit of $7 billion, compared to the $4 billion earned by the firm announcing the regular price. When both firms announce the sale price, the two firms split the market equally (each getting an extra 25 million customers) to earn profits of $2 billion each. When both firms announce the regular price, each company attracts only its 50 million loyal customers and the firms each earn $4 billion in profits. If you were in charge of pricing at one of these firms, would you have a clear-cut pricing strategy? If so, explain why. If not, explain why not and propose a mechanism that might solve your dilemma. ( Hint: Unlike Walmart, neither of these two firms guarantees "Everyday low prices.")