OK, I'll bite. Must be a catch in here somehwere ...
If I drop my price from $10 to $9.50 I get all your 50 customers, don't I ? So my sales go from $500 to $950, my profit goes from $100 to $150 and you are out of business.
The price of beer has dropped 5%.
Knowing you will have to start your price at $9.49 to re-enter the market, you either stay out, or the price falls even further. It continues until neither of us is willing to accept any lower profits -- price stabilizes at our costs + return on investment.
OK, I'll bite. Must be a catch in here somehwere ...No catch. It's a classic game theory example.
If I drop my price from $10 to $9.50 I get all your 50 customers, don't I ? So my sales go from $500 to $950, my profit goes from $100 to $150 and you are out of business.I'm not out of business so quick. I drop my price to $9.50 so we both sell 50 and make $75 (down from $100 each). Your profits have gone down.
Knowing you will have to start your price at $9.49 to re-enter the market, you either stay out, or the price falls even further.Why would I have to come back at $9.49?
It continues until neither of us is willing to accept any lower profits -- price stabilizes at our costs + return on investment.The point is that we are both better off not dropping prices to start. If you thought you could drop your price to $9.50 without me responding, you would do it. But you know I would respond. That's game theory. Why would we race to the bottom when we are both better off standing pat?