Short-Run Constraints and Price Wars
71 Pages Posted: 5 Jun 2017 Last revised: 1 Jun 2022
Date Written: May 31, 2022
Price wars have been explained as occurring because of breakdown of cartels, or as necessary deterrent measures to sustain collusion, or due to imperfect information about demand conditions and/or moves of other firms; and combinations of the above. The above literature, however, fails to explain the repeated episodes of price wars in an industry with instantaneous transmission of information, for example, the U.S. domestic airlines industry. This paper studies different market models with linear and twice differentiable market demand and identical linear costs without capacity constraints, and with almost perfect homogeneity of competitors' products, to demonstrate that, in the presence of short-run constraints (such as insolvency) of firms and of intertemporal substitution of demand (such as with vacation travel or durables), a price war occurs if one or more firm(s) have sufficiently strong short-run constraints - such price wars occur in equilibrium and as part of cooperation. Explicit expressions for prices under survival price wars (which are legal) and predatory price wars (which violate Section 2 of the Sherman Act) are provided along with characterizations of conditions for each variant of price wars. The almost axiomatic assertions by lawyers that a predatory price is necessarily "below cost" is disproved.
Keywords: Intertemporal Substitution of Demand; Vacation Travel; Durables; Short-Run Constraints; Bankruptcy; Predatory Prices; Sherman Act; Capital Market Imperfections.
JEL Classification: C72, D43, L13, L93, K21
Suggested Citation: Suggested Citation