should be emphasized that this result depends on two extreme assumptions—
that (1) all competition is on the basis of price and (2) the lower-price firm
always claims the entire market. We already have seen that quantity compe-
tition leads to quite a different outcome. Furthermore, even if price is the
most important competitive dimension, market shares are unlikely to be all
or nothing.^9 In models with some degree of product differentiation, compe-
tition leads to price reductions, but equilibrium prices remain above the per-
fectly competitive level.374 Chapter 9 Oligopoly(^9) A good example of the Bertrand model is the case of competitive bidding. Here, the firm that sub-
mits the lowest bid price gains the exclusive award of a supply contract. Competitive bidding is
taken up in Chapter 16.
When to Cut
Price
Pricing has been a focus of attention throughout the first half of this book.
Let’s step back for a minute and take stock of the factors that dictate changes
in pricing strategy, in particular, that call for price cuts.
Changes in Market Demand. The surest rationale for a cut in price is an
adverse shift in demand. As we’ve seen, facing a less favorable demand curve
means setting a lower optimal sales target and a lower price. Amid a fall in
demand because of a growing recognition of health risks, tanning salons have
responded by cutting prices. Seeing buyer demand sapped by the ongoing US
recession, Saks Fifth Avenue broke ranks with other upscale retailers by sharply
discounting its prices at the start of the 2008 holiday buying season.
Market Skimming. This strategy of price discriminating over time means set-
ting a high price to pioneer adopters (who have relatively inelastic demand),
then later lowering the price to attract mass-market users (whose demand is
more elastic). Apple’s iphone and ipad both saw significant price discounts
during their first years on the market.
The Learning Curve. As a firm gains cumulative experience producing a
new product, it can expect to reduce its cost per unit by reengineering and
improving the production process. Lower unit costs support lower prices.
More important, it pays for the firm to cut a product’s price at the outset in
order to induce a “virtuous circle” of profitability. The initial price cut spurs
sales and production levels, speeding the learning process, thereby accelerat-
ing cost efficiencies and, in turn, supporting further price reductions—with
additional profit accruing to the firm at each stage. Strong learning curve
effects have been documented for a range of assembly-line products: from air-
craft to laptops to photocopiers.
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