Edgeworth Price Cycle
Categories: Financial Theory, Accounting
If you've ever heard of price "stickiness," the Edgeworth price cycle is on the opposite end of that price spectrum. Sticky prices are prices that are slow to change, even if they theoretically should. For instance, McDonald's doesn't constantly change the price of their Big Mac as the supply and prices of cheese and lettuce change in the background.
The Edgeworth price cycle is where prices jump up, then incrementally decline downwards to where they started.
For instance: gas prices. First, the invisible hand of supply and demand keeps gas stations competitive. In the gas world, that means gas prices that are as low as possible for the companies...they undercut each other until they can't anymore. Yet none of the gas stations like this. They're all barely making money. Eventually, one gas station throws its hands in the air and says, "Enough of this! I'm raising my gas prices!" to which the other gas stations say, "Where did you get hands?" And, "Well, if they're raising their prices, we can raise ours too!" Then all the gas companies are happy, but customers are not.
Not too long after, many customers are willing to go to a different gas corner than usual...whoever has the lowest prices. The gas stations then undercut each other, bit by bit, until gas prices are down to where they were before.
The Edgeworth price cycle is worth it for businesses, because at the end of the day, they will make a bit more money during those periods of price hikes. Edgeworth price cycles are more likely to happen in competitive markets selling homogenous goods, like gas. It's pretty much the same everywhere.
A Big Mac versus an In-n-Out burger versus a Whopper? While those are all burgers, they are definitely not homogenous goods. Each burger has its audience that prefers that specific burger, unlike gas in your car which is like, ehhhh...who cares? Because we care about which burger we get, companies don't have to worry about each other undercutting each other as much. Brand loyalty and engineered flavors are real economic game changers.