Alpha Corp . and Beta Corp . are the only firms in an industry. It is found that Alpha loses its entire market share to Beta when Beta lowers its price. What is the optimum pricing strategy for Alpha?

Question

What will be an ideal response?

Answer 1

Alpha and Beta are operating in a duopoly with homogeneous products. Because the firms produce identical products, a slight reduction in the price charged by one firm causes its rival to lose all its customers to this firm. The optimal strategy for firms in this case is to lower price as long as the rival's price exceeds the marginal cost of production. This process of lowering price slightly below the rival's price is known as undercutting. Such price cutting in a duopoly with homogeneous products continues as long as price exceeds marginal cost. In equilibrium, both firms charge a price equal to marginal cost. This equilibrium is called the Nash equilibrium because once this equilibrium is reached, neither firm can increase its profit further by changing its strategy.