Tuesday, June 16, 2009

Gasoline Price War

It has been reported that two retail gasoline stations in Pasenda California were in a price war over the retail gasoline, which is firm behavior that is consistent with the homogeneous Bertrand oligopoly model. This economic model states that if there are a few firms selling an indentical product - from the customer's perspective - and the marginal costs of manufacturing (or in this case - retailing) are the same for both firms, that each firm has an incentive to set its price below their rival. With each firm having an incentive to lower prices, we may observe a price war.

The problem from the firm's perspective is that lowering prices may actually lead to decreasing profits, even if they are able to increase the volume of gasoline sold with the lower prices. This is especially detrimental to the firm if their customers are price inelastic - as is the case with retail gasoline, and a topic I have written about earlier.

Theoretically, what is interesting is the factors that lead to price wars in the first place, along with the impact this has on firm profitability.

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