Dynamic Pricing in Declining Demand: The Case of Duopoly

The purpose of this study is to investigate what theory predicts about price dynamics when firms face a decline in demand for their product due to an arrival of a new substitutable product. To this end, this paper constructs a dynamic duopoly model and simulates price paths. The study demonstrates that the price path is nonmonotonic and could be divided into three stages. The basic mechanism of generating the path is a tradeoff between two counteracting motives to set the price: pricing lower to delay the adoption of the new product, and pricing higher to exploit price-insensitive consumers.