Dynamic Price Competition with Persistent Consumer Tastes

Abstract

The dynamic price competition in a horizontally differentiated duopoly when consumers value previous market shares is analyzed. The conditions for the existence of stable Markov-Perfect Equilibrium(MPE) in linear strategies are established. When they exist, the optimal pricing policies suggest that a firm with a higher previous market share charges a higher price, all else equal. It is possible to observe pricing below cost for some periods. In the steady state, the MPE leads to a more competitive outcome (lower prices) than the case where there is no persistence in consumer tastes. The model can produce outcomes where the steady state is reached very slowly which provides an alternative explanation for slow emergence of competition when entrants face an established incumbent: It may be due to persistence in consumer tastes.