Question

Price comparison services on the Internet (as well as “shopbots”) are a popular way for retailers to advertise their products and a convenient way for consumers to simultaneously obtain price quotes from several firms selling an identical product. Suppose that you are the manager of Digital Camera, Inc., a firm that specializes in selling digital cameras to consumers that advertises with an Internet price comparison service. In the market for one particular high-end camera, you have only one rival firm—The Camera Shop—with which you’ve competed for the last four years by setting prices day after day. Being savvy entrepreneurs, the ease of using the Internet to monitor rival firms’ prices has enabled you and your rival to charge extremely high prices for this particular camera. In a recent newspaper article, you read that The Camera Shop has exhausted its venture capital and that no new investors are willing to sink money into the company. As a result, The Camera Shop will discontinue its operations next month. Will this information alter your pricing decisions today? Explain.

Short answer

The manager of the firm Digital Camera will charge a low price for the last month of its operation.

Step-by-step solution

Introduction 

The firm Digital Camera and the Camera Shop have the same product. They have been competing for four years also. This time, both firms have cooperated and loaded the Nash equilibrium that generates the highest payoff. They know that tomorrow the rival company will make the same decision. That is, a (high price, high price) strategy for both firms.

Explanation why the Camera Shop will discontinue its operations next month 

The Camera Shop will go out of the market in a month, and thus a situation of repeated games with a known final period will be generated. If in the last period any of these firms decide not to cooperate and collude, the injured firm cannot punish its rival in the third period.

Therefore, each firm in this last period will choose the option that it would use on the one-shot version of the game. Charging a low price is the best decision in this condition. Digital Camera in this last period will not charge a high price but a low price to obtain a higher payoff. However, the Camera Shop knows this and will also choose the option of a low price so as not to obtain loss to play the high price.

Therefore the digital camera manager will change a low price for the last month The Camera Shop will be competing.