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Definition: Edgeworth Price Cycle
In an oligopolistic market (market dominated by small sellers and vendors), the consumers are highly price sensitive to a homogenous product. Thus if any of the vendor reduces the price – an asymmetric price variation occurs. As the vendor lowers the price, other competitors are bound to cut the prices as that they don’t lose the market. This continues until price reaches the wholesale cost. Eventually, the price of the good is returned to the previous level (allowing normal retailer profit) by the competitors. This cycle may arise very rapidly in a highly competitive market, and such a cycle is called edge worth price cycle.
Thus there are three characteristics of this cycle:
• Goods are homogenous in nature and customers are price sensitive.
• Market starts from equilibrium, wherein a competitor initiate a price cut cycle below equilibrium. As this happens, other competitors are bound to respond as quickly as possible so as to maintain the market share.
• Until the price reaches the wholesale cost, undercutting is continued.
• A competitor then resets the price and everyone then follows again quickly.
• This cycle then repeats in due course of time.
Here generally smaller players are price cutters while large players are initiators of price restoration.
For example: Generally it is demonstrated in gasoline markets as the market comprises of many small retailers. Therefore price of gasoline fluctuates very frequently. To avoid price cut, retailers add different additives to gasoline to make it a superior brand as compared to others. Also to avoid price fluctuation, weekly average prices set by government masks these cycles.