Question

Many home improvement retailers like Home Depot and Lowe’s have low-price guarantee policies. At a minimum, these guarantees promise to match a rival’s price, and some promise to beat the lowest advertised price by a given percentage. Do these types of pricing strategies result in cutthroat Bertrand competition and zero economic profits? If not, why not? If so, suggest an alternative pricing strategy that will permit these firms to earn positive economic profits.

Answer 1

The promise to meet the lowest price offered by the competitors, leads to the price war and it makes firms to cut the prices where the price becomes equal to the marginal cost. It creates Bertrand paradox and it harms to the firms as their profits comes down. In this condition, firms can collude with each other so that they set the prices and do not change to generate profit. Alternatively, firms can produce differentiated products with value based pricing to succeed in the market. It will bring positive economic profit. Alternatively, firms can collude to set prices in their area of operation and do not cheat each other. It makes them earn a positive economic profit.