Question

every cafe near campus agrees to raise the price of coffee from $3 to $5 per cup. this allows every seller to increase profits on a popular item. however, if any seller defects from the agreement and charges $4 for coffee instead, most customers will switch to buy coffee from the lower-cost cafe. in the short term, the defecting cafe will enjoy high profits while the other cafes will not. as cafe owners consider the optimal strategy to maintain long-run profits, how should they think of the interactions with other campus businesses?

Answer 1

Cafe owners should consider the prisoner's dilemma in game theory and recognize the inelastic demand of coffee when deciding whether to maintain a pricing agreement. Defecting may lead to immediate gains but long-term destabilization and lower profits for all. Cooperation and differentiation can provide sustainable long-term profits.

Step-by-step explanation:

Considering the scenario of cafes near campus raising the price of coffee, the owners should evaluate the situation within the framework of game theory and market dynamics influenced by supply and demand. Each cafe faces a strategic decision, similar to the prisoner's dilemma, where they can either cooperate and maintain higher prices for mutual benefit or defect and lower prices in hopes of attracting more customers short-term but risk destabilizing the market agreement.

In the context of elasticities of demand, coffee tends to have an inelastic demand, meaning consumers have less sensitivity to price changes. Thus, small declines in price may not lead to significantly higher quantities consumed, as evidenced by an elasticity of 0.3 for coffee demand. However, if a cafe lowers its price, the disequilibrium created may lead to notable customer migration to the lower-priced option, undermining the collective pricing strategy.

Therefore, the most sustainable long-term strategy for maintaining profits may involve sticking to the agreed higher price while also focusing on differentiating their products or services to add value to customers. Alternatively, engaging in a price war may lead to a detrimental race to the bottom, eroding profits for all cafes over time.

Answer 2

Campus businesses facing the dilemma of pricing strategy for coffee should consider the inelastic nature of demand and market supply shifts. Price coordination is vital for long-term profitability, with adaptability to cost changes and external market conditions playing a crucial role.

Step-by-step explanation:

In the scenario where campus businesses have agreed to raise the price of coffee and face potential defection for short-term gains, the long-run profits depend on maintaining a competitive yet cooperative equilibrium. It is essential for these businesses to think through the implications of elasticity of demand and market supply shifts. Considering the relatively inelastic nature of coffee demand, a significant increase in price will only marginally reduce the quantity consumed. Therefore, the defection of a single cafe may cause an initial shift in customer loyalty, but price coordination among businesses can ensure stability and profitability for all in the long term. Furthermore, external factors such as a change in the cost of production should prompt all cafes to adjust prices accordingly. Lastly, the natural adjustments in market dynamics, as seen with examples like Brazil’s frost-affected coffee crops or Vietnam's entrance into the market, underpin the importance of adaptability and strategic pricing in maintaining market equilibrium without the need for detailed government oversight.