OnWheels and Speedstar are the only two manufacturers of sports cars. The cars manufactured by these companies are considered to be close substitutes, but are not identical. How should each firm determine its price in this case?

What will be an ideal response?

Because the companies' products are considered to be similar, if either firm cuts its prices, it will gain market share from the other. However, the firms' products are not exact substitutes. Therefore, the price-cutting company will not be able to take the entire market just because it prices a bit lower than the other firm. Some people are still going to prefer its competitor's product, even at a higher price. In this case, each firm must put itself in the other's shoes to recognize how its prices will affect the prices of its competitor. The executives at OnWheels must estimate the demand for Speedstar cars given every possible price for their cars. They can then construct their optimal price for every possible price of Speedstar cars. Speedstar should make the same calculations in order to figure out its best response to changes in prices charged by OnWheels. The equilibrium reached through this process is called the Nash equilibrium because both firms in the industry maximize simultaneously so that their prices are best responses to each other.