Loss-Leaders: A Phenomenon of Price Competition or Implicit Collusion

In this paper we analyze equilibrium pricing strategies for firms competing in a market for two goods consumed by two types of consumers. It is shown that if the proportion of poor to rich consumers is not too small or too large, equilibrium pricing strategies result in a kind of symmetric price dispersion which can be interpreted as the phenomenon of loss-leaders. It is also argued that although in some situations this equilibrium leads to a collusive solution, for other parameter values it can be a way out of a prisoner’s dilemma. All other Nash equilibrium strategies are also characterized. The analysis is then extended to a multi-period setting to demonstrate that equilibrium pricing strategies can result in different types of temporal price dispersions which provide an explanation for the phenomenon of price promotions.