DEFINITION of 'Edgeworth Price Cycle'

An Edgeworth price cycle is a high-frequency asymmetric retail price cycle that is observed in gasoline markets around the world, in which a sharp increase in prices is followed by a sequence of incremental price cuts until prices reach wholesale cost.

BREAKING DOWN 'Edgeworth Price Cycle'

Edgeworth price cycles differ from price stickiness, which is typical of less competitive markets, with fewer price cycles, and variable cost-plus pricing where the price tracks wholesale price variations. In highly competitive Edgeworth markets, with homogenous goods, there are many small competing retailers. However, there are enough loyal consumers who will buy regardless of the prices charged, that some firms may benefit temporarily from hiking prices and exploiting this small segment rather than trying to win the whole market. The result is high frequency cyclical price patterns, which follow three phases:

  • War of attrition: Firms engaged in a war of attrition and pricing at marginal cost, hope that the competitor will relent and raise their prices.
  • Jump: The market price jumps when one firm relents and the others raise their prices to a level which still undercut the first mover.
  • Undercutting: Firms then take turns at undercutting each other until the market price returns to the equilibrium low war of attrition price.

This type of recurring price war hurts profits — and there is some evidence that it leads to lower margins in the long run. Edgeworth price cycles are difficult to avoid in markets where consumers are highly price sensitive, and competitors are, within days, forced to reset prices to their previous levels, close to the wholesale cost.

The Federal Trade Commission has found evidence of Edgeworth cycle-like pricing behavior in gasoline retail in some U.S. cities. To differentiate themselves and reduce the market’s homogeneity, gasoline retailers insert additives which supposedly make the brand of gasoline superior to others. However, such attempts at differentiation have met limited success.

Edgeworth price patterns were identified in 1988 by Maskin & Tirole in their theoretical duopoly pricing game featuring two firms bidding sequentially and where the winner captures the full market.

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