On Price Recognition and Competition with Boundedly Rational Consumers
We study an extension of the model of Rubinstein (1993) to two firms, competing in a market with consumers who are boundedly rational with respect to processing information. The cognitive bound forces customers to partition the price space. Rubinstein shows that a monopolist is able to earn a higher profit by exploiting consumers’ lack of processing ability. We extend his model to a duopoly, and show the Nash and Correlated equilibria of the game. We prove that in competition, whether firms choose their strategies independently or dependently, firms joint profit is lower than in a monopoly but does not vanish completely. The uncertainty regarding the consumers’ cutoff point and differences across firms’ prices impel firms to set their prices equal to the marginal cost.
Number of Pages in PDF File: 19
Keywords: Bounded rationality, Duopoly, Pricing policy
JEL Classification: D43, C72, L13
Date posted: June 8, 2012