Going-rate pricing and the leaders reactive policy in a duopoly market

Abstract

Going-rate pricing is quite popular in practice. Many small firms base their prices largely on the leading competitors price and change the prices when the market leader changes its price. Under the policy, the amount of the price difference is preserved. However, there has been no explicit analysis about this popular pricing policy. In this paper, we analyze a duopolistic linear demand model that incorporates the price differential effect. We investigate one frequently mentioned explanation for the going-rate pricing, which we call Vicarious Information Hypothesis. It is shown that going-rate pricing that preserves the amount of price difference is not warranted under the explanation. The followers should adaptively change the amount of price difference. Some insights about the proper amount of price difference are suggested through our analysis. We also analyze the price leaders policy that takes advantage of the followers going-rate pricing using the Bayesian framework. When the leader does not have perfect information about the amount of price difference considered by the follower, the optimal pricing policy is shown to be myopic in the sense that it should maximize current expected sales or profit after updating its subjective distribution about the amount of price difference.