What is the Edgeworth Price Cycle?

An Edgeworth price cycle is a cyclical, asymmetric sequence that is observed in the gasoline markets across the globe. The cycle demonstrates a rapid increase in prices and the followed by gradual decreases in prices to come back to the initial cost.

How Does the Edgeworth Price Cycle Work?

Maskin & Tirole (1988) identified the Edgeworth pricing pattern when conducting research on a theoretical duopoly pricing game between two retailers. Generally, an Edgeworth market is characterized by high competition among a number of smaller, competing retail firms that sell the same or similar goods. Some of these firms will raise prices to extract slightly more value from loyal customers who will not change to a competitor because of the higher prices. These firms will benefit in the short run from these price increases. Generally, however, these firms compete at the margin selling their products almost at the marginal cost of production. This scenario often results in a cyclical pattern as follows:

• Attrition: Firms price at marginal cost hoping that they can outlast other firms. This is a highly-competitive environment with very little profit margin.
• Jump in Prices: When one competitor relents from the price war and raises its prices, the rest of the market joins suit but raise their prices to a level slightly below that of the first firm. This is a significant price jump above the market equilibrium.
• Undercutting: The firms then continue to compete on price (cutting prices incrementally) until the price reaches a market equilibrium again.

The general consensus is that this competitive cycle ultimately lowers profits and leads to lower profit margins in the long run. Unfortunately, this cycle is prone to occur in markets in which customers are very price sensitive and retailers are able/required to reset prices quickly to match competitors.