Price Floors and Competition

Abstract

A potential source of instability of many economic models is that agents have little incentive to stick with the equilibrium. We show experimentally that this may matter with price competition. The control variable is a price floor, which increases the cost of deviating from equilibrium. Theoretically the floor allows competitors to obtain higher profits, as low prices are excluded. However, behaviorally the opposite is observed; with a floor competitors receive lower joint profits. An error model (logit equilibrium) captures some but not all the important features of the data. We provide statistical support for a complementary explanation, which refers to how "threatening" an equilibrium is. We discuss the economic import of these findings, concerning matters like resale price maintenance and auction design.Price competition; price floors; Bertrand model; experiment; salience; logit equilibrium; threats