OnWheels and Speedstar are the only two manufacturers of sports cars. The cars manufactured by these companies are considered to be close substitutes, but are not identical. How should each firm determine its price in this case?
What will be an ideal response?
Because the companies' products are considered to be similar, if either firm cuts its prices, it will gain market share from the other. However, the firms' products are not exact substitutes. Therefore, the price-cutting company will not be able to take the entire market just because it prices a bit lower than the other firm. Some people are still going to prefer its competitor's product, even at a higher price. In this case, each firm must put itself in the other's shoes to recognize how its prices will affect the prices of its competitor. The executives at OnWheels must estimate the demand for Speedstar cars given every possible price for their cars. They can then construct their optimal price for every possible price of Speedstar cars. Speedstar should make the same calculations in order to figure out its best response to changes in prices charged by OnWheels. The equilibrium reached through this process is called the Nash equilibrium because both firms in the industry maximize simultaneously so that their prices are best responses to each other.
You might also like to view...
Mr. Adams owns a textile business. In order to deal with the principal-agent problem, Mr. Adams might offer his employees
A) incentive pay. B) long-term contracts. C) part- ownership. D) all of the above.
How does government support of health and education programs foster economic growth?
What will be an ideal response?
Assuming the existence of economies of scale, if a firm finds that it can reduce its unit cost by decreasing its scale of production, it means that
A) it has too much production capacity relative to its demand. B) it should try to produce less. C) the law of diminishing returns has not taken effect. D) it has too much fixed overhead relative to its variable cost.
A potential problem arises in principal-agent relationships
a. because the agents' actions are not always observed by the principals b. because the principals' actions are not always observed by the agents c. because the agent's and the principals' actions are always observed by each other d. the observability of actions is irrelevant