Let's use an oligopoly model to understand why it may be better for competing firms if one of them assumes the role of a price leader (ABI in this story), while others follow (MillerCoors'), relative to a situation where they choose price simultaneously (not literally simultaneously, but when one chooses its pricing strategy it does not know the pricing strategy of rivals). Use a Bertrand duopoly price competition model with product differentiation to demonstrate that prices and profits are greater if firms sequentially set prices than if they simultaneously set prices. The point of the model is to demonstrate that firms are better off with leader-follower pricing than with simultaneously pricing. More specifically, use D_1 = a -p_1 + p2/2 and D_2 = a - P_2 + p1/2 as the demand functions for the two firms, 1 and 2, and assume zero marginal cost.
1. Solve the game first by assuming that firms set their prices simultaneously.
2. Then solve it again by assuming that firm 1 is the leader (sets its price first) and firm 2 is the follower (after observing the price of the leader it sets its own price). I11 both cases the firms compete with each other (no collusion).
3. Compare the equilibrium prices and profits between a) and b) above. Which one yields higher prices and profits? What is the intuition? In developing an intuition use the taxonomy we discussed in lecture (strategic complements vs. substitutes and tough vs. soft commitments).