Price Competition in the Manhattan Pizza Market Bombay/6 Ave. Pizza and Joey Pepperoni’s Pizza are located close to each other on Sixth Avenuein Manhattan. There are 450 potential customers every day, and suppose that each of them iswilling to pay up to $2 for a slice of pizza. Since the two shops are selling almost identical pizza, customers always prefer to buy from the cheaper one. (If they charge the same price, then they will split the market equally.) It is also known that each pizza shop can supply at most 600 slices of pizza every day, and theproduction cost for each slice of pizza is 80 cents. Suppose that the owner of each shop takes ashort-run perspective and only wants to maximize each day’s profits, and no shops are going toshut down in the short run. a) What is the appropriate economic model to study price competition in this local pizzamarket?b) If you use Nash equilibrium to make a prediction, what price is each shop going tocharge? Explain your reasoning.c) Give two possible practical means by which the two shops could earn more thanpredicted in b).d) If Bombay/6 Ave. Pizza reduces its unit production cost to 70 cents. How will yourprediction in b) change? From now on, return to the case where both shops have the same cost of 80 cents. Suppose thatthe market size has doubled and there are 900 potential customers. Suppose each existing shop’sproduction capacity of 600 pizzas remains unchanged. As a result, no shops can serve the wholemarket solely. e) Is each of the following pricing strategies a NE? Justify your answer.(i) Each shop sets a price of 80 cents; (ii) Each shop sets a price of $2.
Bombay/6 Ave. Pizza and Joey Pepperoni’s Pizza are located close to each other on Sixth Avenue
in Manhattan. There are 450 potential customers every day, and suppose that each of them is
willing to pay up to $2 for a slice of pizza. Since the two shops are selling almost identical pizza, customers always prefer to buy from the cheaper one. (If they charge the same price, then they will split the market equally.)
It is also known that each pizza shop can supply at most 600 slices of pizza every day, and the
production cost for each slice of pizza is 80 cents. Suppose that the owner of each shop takes a
short-run perspective and only wants to maximize each day’s profits, and no shops are going to
shut down in the short run.
a) What is the appropriate economic model to study price competition in this local pizza
market?
b) If you use Nash equilibrium to make a prediction, what price is each shop going to
charge? Explain your reasoning.
c) Give two possible practical means by which the two shops could earn more than
predicted in b).
d) If Bombay/6 Ave. Pizza reduces its unit production cost to 70 cents. How will your
prediction in b) change?
From now on, return to the case where both shops have the same cost of 80 cents. Suppose that
the market size has doubled and there are 900 potential customers. Suppose each existing shop’s
production capacity of 600 pizzas remains unchanged. As a result, no shops can serve the whole
market solely.
e) Is each of the following pricing strategies a NE? Justify your answer.
(i) Each shop sets a price of 80 cents; (ii) Each shop sets a price of $2.
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