Question

Price competition between firms, from the firms’ perspective, can be similar to the prisoners’ dilemma. The best outcome for all firms would be for all to charge a high price. However, if the other firms charge a high price, any individual firm has incentives to charge a low price and steal the market. Additionally, if any other firm chooses a low price, each firm should charge a low price too so that it doesn’t get priced out of the market. Explain how price-matching (firms announcing a policy where they match the lowest price a customer can find or will honor a competitor’s coupon) can help firms avoid the Nash equilibrium in which they all charge a low price. Is it misleading for a firm to advertise price-matching as being beneficial to consumers? (Hint: What outcomes of the game are ruled out by the price-matching policy? How does ruling out these outcomes change the game and the decision the firms face?)

Answer 1

Price competition b/w firms, from the firms' perspective, can be similar to the prisoners' dilemma. Here, the best outcome would be for all to charge a higher price.

Yes it is misleading for a firm to do that because it's not for the customer's benefit, it's fo the companies' own benefit.

Price matching policy puts all the firms in a different place where the best decision for all would be to charge a lower price. Best policy for business here is trust and cooperation.

If all of them maintain a higher price and trust each other that noone will lower down the price, they can attain mutual benefit