Edgeworth Price Cycle

What Is the Edgeworth Price Cycle?

The Edgeworth Price Cycle is a pattern of price changes that outcome from competition between organizations that sell something similar or comparable merchandise — generally, commodified products.

Albeit the competition that makes the Edgeworth Price Cycle might benefit individual companies in the short term, it is generally hindering to those companies in the long term.

How the Edgeworth Price Cycle Works

The Edgeworth Price Cycle is associated with markets in which the customers are very price sensitive. These customers are concerned essentially with getting the lowest price conceivable and will actually want to switch between companies for even an unassuming diminishing in costs. Hence, companies in these markets will monitor each other's prices and craftily reduce them to gain market share.

In the long term, notwithstanding, this cycle can be pointless for the companies in question, lowering profit margins in the long term. The main permanent solution to this problem would be for companies to prompt additional loyalty from their customers, yet this might be difficult to accomplish in the event that the product being referred to is exceptionally commoditized and there is a ton of contending suppliers for it.

Stages of the Edgeworth Price Cycle

This pattern of competition in the Edgeworth Price Cycle generally follows three unsurprising stages.

In the principal stage, the firms participate in a war of attrition in which they cut prices endlessly lower. Assuming this cycle proceeds with sufficiently long, prices will come to their marginal cost, implying that further price cuts will lead to losses for the company.

In the subsequent stage, a few firms will abandon the price-cutting strategy and firms will start raising their prices to some place close where they were before the price-cutting started.

Yet again in the third stage, one more series of price cuts will begin as firms jar to gain market share by cutting prices.

This cycle can repeat itself endlessly since the products being sold are somewhat undifferentiated and customers can undoubtedly switch between companies. Thus, there will continuously be a short-term incentive for contenders to fall once more into the pattern of the Edgeworth Price Cycle.

Edgeworth Price Cycles are the leading theory behind the price changes that show up in many retail gasoline markets around the world, especially in North America, Australia, and Europe.

Special Considerations

Here and there companies in these types of Edgeworth Price Cycle-sensitive markets will frequently partake in some unobtrusive amount of loyalty from their customers. That can make incentives for those companies to take on a contrarian position and keep up with or raise their prices while others are attempting to reduce them.

For example, on account of gas stations, customers likely could be sensitive to price yet will likewise favor buying from the gas stations nearest to them or exceptionally advantageous to them (close to their place of work, shopping center, and so on.).

Thus, a gas station that is arranged in a decent area — right close to an entrance to the turnpike, for instance — could likewise conflict with the trend of an Edgeworth Price Cycle and keep up with or increase prices when its rivals are cutting them. Assuming enough of that company's customers stay steadfast, the contrarian player could get more cash-flow than if it had attempted to contend by lowering prices.

History of the Edgeworth Price Cycle

At the point when plotted on a graph, the prices in an Edgeworth Price Cycle rise and afterward fall in a slowly declining step or saw-tooth pattern. Hence, it is viewed as an asymmetrical price cycle.

The idea of a seriously driven, dynamic, asymmetric price cycle traces all the way back to Francis Ysidro Edgeworth (1845-1926), an economist and analyst. In one of his major works, collected in Papers Relating to Political Economy (1925), he contended that when marginal costs were expanding (or firms were capacity compelled in the extreme case), prices firms would undercut each other to gain market share, until prices were low sufficient that one firm could profitably raise them and serve the residual demand.

In any case, it was only after 1988 that the Edgeworth Price Cycle theory was formalized — and given its name — in a paper by economists Eric Maskin and Jean Tirole, "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," distributed in Econometrica.

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Features

• The Edgeworth Price Cycle portrays how prices can vary under conditions of aggressive price competition.
• In these conditions, companies face short-term incentives to contend on price, however this competition can lead to long-term declines in profit edges.
• While most firms contend to lower prices during the Edgeworth Price Cycle, some embrace a contrarian approach and keep up with or raise their prices.
• It is fundamentally seen among companies selling commodified products, like gasoline.