Edgeworth Price Cycle Definition
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.
A Little More on the Edgeworth Price Cycle
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.
References for Edgeworth Price Cycle
Academic Research on Edgeworth Price Cycle
EDGEWORTH PRICE CYCLES: EVIDENCE FROM THE TORONTO RETAIL GASOLINE MARKET*, Noel, M. D. (2007). The Journal of Industrial Economics, 55(1), 69-92. The author uses a new station‐level, twelve‐hourly price dataset to explore the retail price cycles in Toronto gasoline market. The cycle appears strongly asymmetric, tall, rapid, and highly synchronous in different stations. The appearance is quite similar to the theoretical Edgeworth Cycles. The author tests a series of predictions, of how the firm behavior would differentially evolve over the path of a cycle, made by the theory.
Edgeworth price cycles, cost-based pricing, and sticky pricing in retail gasoline markets, Noel, M. D. (2007). The Review of Economics and Statistics, 89(2), 324-334. This article studies the dynamic pricing behavior in Canadian retail gasoline markets. The author discovers three pricing patterns: cost-based pricing, sharp asymmetric retail price and sticky pricing cycles similar to the theoretical Edgeworth cycles. The author estimates the frequency of the regimes and then structural patterns of the cycles by using the Markov-switching regression. He finds that the cycles are more frequent when the number of small firms is increased, and the cycles are accelerated and multiplied with numerous small firms.
A theory of dynamic oligopoly, II: Price competition, kinked demand curves, and Edgeworth cycles, Maskin, E., & Tirole, J. (1988). Econometrica: Journal of the Econometric Society, 571-599. The authors provide theoretic foundations for the traditional kinked demand curves and Edgeworth cycles. This paper includes the analysis of a model which allows the firms to take turns in deciding the price. This model was designed to capture the idea of reactions from short-run commitments. The authors then develop the timing by allowing the firms to move at any time subject to the short-run commitments.
Edgeworth price cycles and focal prices: Computational dynamic Markov equilibria, Noel, M. D. (2008). Journal of Economics & Management Strategy, 17(2), 345-377. Stimulated by the detection of Edgeworth Cycles in gasoline retail markets, the author expands the Edgeworth cycle theory along the key aspects, including differentiation, capacity constraints, and triopoly, and models of wavering marginal cost. Edgeworth cycles remain in equilibrium in most cases and the shape of the cycles give information about underlying competitive intensity.
Edgeworth price cycles, Noel, M. D. (2011). Edgeworth price cycles. New Palgrave Dictionary of Economics. Palgrave Macmillan. Edgeworth Price Cycles are an asymmetric model of prices that are gotten from a continuous pricing equilibrium among competing oligopolists. Edgeworth Price cycles are the currently the best theory for explaining the asymmetric price cycles observed in the United States, Canadian, Australian and European gasoline retail markets.
The speed of gasoline price response in markets with and without Edgeworth cycles, Lewis, M., & Noel, M. (2011). Review of Economics and Statistics, 93(2), 672-682. Wholesale price changes have minimal effect on retail gasoline prices (slow response). That is not so for markets with Edgeworth price cycles. The authors show that changes in cost in cycling markets occurs two to three times faster in markets without cycles. They argue that the constant price movement intrinsic to the Edgeworth cycle prevents price frictions and permits firms to transmit price fluctuations easily.
Edgeworth price cycles in gasoline: Evidence from the United States, Zimmerman, P. R., Yun, J. M., & Taylor, C. T. (2013). Review of Industrial Organization, 42(3), 297-320. Existing research on gasoline prices shows that a sharp increase in price is immediately followed by gradual increases in multiple countries. This pattern is linked to Maskin and Tirole duopoly pricing game and the Edgeworth price cycles. The authors explore about 350 MSAs daily in the US from 1996-2010. From the data gathered it was observed that MSAs began cycling in 2000 and that prices were lower in MSAs that began cycling.
Edgeworth Price Cycles and intertemporal price discrimination, Noel, M. D. (2012). Energy Economics, 34(4), 942-954. This paper classifies the purchase timing strategy into four classes. These strategies were created to push purchases from consumers towards the cycle troughs. Results from studies in Toronto, Canada show that with the use of optimized strategies, monetary gains to consumers are as high as 3.9%. while markups gained from the consumers fall to about 82%. The article also discusses the implications of the Policy.
The dynamics of price dispersion, or Edgeworth variations, Cason, T. N., Friedman, D., & Wagener, F. (2005). Journal of Economic Dynamics and Control, 29(4), 801-822. The authors test the hypotheses on the dynamics of price gotten from computer simulations. They test using data obtained from the laboratory. As the Edgeworth hypothesis predicted, the data presented an important cycle. The paper gives a detailed description of the cycle gotten from the experiment. A mixture of logit dynamics and gradient dynamics splendidly reproduce the observed dynamics.
Do Edgeworth price cycles lead to higher or lower prices?, Noel, M. D. (2015). International Journal of Industrial Organization, 42, 81-93. Recent studies focus on the causes of high-occurrence, asymmetric retail price cycles that is seen in many gasoline markets. Most don’t pay attention to the impacts of the cycles, majorly whether the cycles result in lower or higher price and margins. Edgeworth price cycle, which is the most popular theory used to explain the cause of the price cycles, does not say anything on the issue. In this article, the author employs a distinct natural experiment to determine the effects of the cycles. He discovered that Edgeworth price cycles result in lower prices and margins.
Bertrand-Edgeworth competition in experimental markets, Kruse, J. B., Rassenti, S., Reynolds, S. S., & Smith, V. L. (1994). Econometrica: Journal of the Econometric Society, 343-371. The competition that exists among the groups of sellers that decide prices is fully described in the Bertrand-Edgeworth (BE) model. The authors write on the laboratory experiments that were created to capture the important characteristics of BE competition. With the aid of the experiment, they were able to examine different theories of BE competition: Edgeworth cycles in prices, Competitive equilibrium (CE) pricing, tacit collusion. and mixed strategy Nash equilibrium (NE) in prices
Edgeworth cycles revisited, Doyle, J., Muehlegger, E., & Samphantharak, K. (2010). Energy Economics, 32(3), 651-660. Maskin and Tirole described a model of Edgeworth price cycles whose pattern is consistent with that of the price cycles exhibited by some gasoline markets. In this article, the authors expand the model created by Maskin and Tirole. They also test its prediction with new data of daily station-level prices gathered from 115 U.S cities. The results obtained were fully discussed in the article.