Price Matching Hurts Consumers by Creating Price-Fixing Cartels

At first, price matching seems like a good thing for shoppers. I have a Cartel Max store very close to my house, which has Product A selling for $99. But Hurt Consumers City sells Product A for $79. I just go to Cartel Max, show them the Hurt Consumers City advertisement showing the lower price, and Cartel Max will match. I get Product A for $79 without having to drive all the way to Hurt Consumers City. What a good deal for me!

Well think again. Matching policies actually perpetuate price fixing, creating a de facto cartel. Here's how.

Imagine the market without matching. Cartel Max can produce or buy Product A for $20. Cartel Max then sells at a higher price to make a profit (and to account for overhead, advertising, etc.), let's say $50. Hurt Consumers City does the same, selling Product A for $50. Since consumers pay $50 whether purchasing at Cartel Max or Hurt Consumers City, they have no reason to choose one over the other. Generally, each company will sell equal amounts of Product A, in this case 50%. Neither company can raise its price. If Cartel Max decides to raise to $60, everybody will chose to purchase from Hurt Consumers City.

Then one day, an innovative Hurt Consumers City manager comes up with a great idea. She decides to lower the price of Product A to $40. Now, when somebody wants to purchase Product A, he can pay $50 at Cartel Max or $40 at Hurt Consumers City. As you might expect, almost everybody chooses the lower price at Hurt Consumers City. And since Hurt Consumers City sells more of Product A, they make more profit despite the lower price.

But Cartel Max is smarter than that. Cartel Max cuts to $30, taking all the sales from Hurt Consumers City. This keeps happening until the price reaches market equilibrium. This is just fancy economist talk for the fair, stable price. Since both companies buy/product Product A for $20, the market equilibrium would be $20 plus expenses, and a small profit margin.

This is what typically happens in competitive free markets. This is why you hear so many great things about free market competition and efficiency.

But let's see what really happens in our previous scenario. Both companies buy/produce Product A for $20 still. But then both charge $50. Both companies implement a matching policy.

First, let's see what happens when Cartel Max raises to $60. Without Price matching, Cartel Max lost all of its sales to Hurt Consumers City. But with matching, people can PM to Hurt Consumers City and get Product A for $50. A few consumers won't notice the lower price at Hurt Consumers City, and will then pay the higher. But essentially, raising the price has no effect in the PM scenario.

But more importantly, what happens when Hurt Consumers City decides to undercut? Hurt Consumers City charges $40 while Cartel Max charges $50. In the previous scenario, Cartel Max lost all its sales and had to lower its price to stay competitive. But in the new scenario, I can just go to Cartel Max and purchase Product A for $40 with a PM. Cartel Max is fine and doesn't need to lower its price. And of course, it doesn't. The innovative Hurt Consumers City manager, realizing her lower price did not increase profits, decides to go back to $50.

In cartels, which are illegal in the United States, companies gang up and agree to fix prices. They agree not to undercut the other cartel members. This creates huge profits for the companies and hurts consumers, who end up paying more than they would have to pay if the companies competed against each other. That's why cartels are illegal in the United States.

But price matching essentially sets up a cartel. The companies don't meet up and fix prices, so it's not illegal. But matching does fix prices, since neither company has to worry about the other cutting its prices and taking away sales.

Price matching hurts shoppers. Like a cartel, perhaps matching should be illegal.