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Competition in Price and Availability when Availability is Unobservable

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  • James D. Dana

    (Northwestern University)

Abstract

This paper presents a strategic model of competition in both price and availability when firms can publicly commit to prices but not inventories (or capacities). Demand is uncertain and firms stock out in equilibrium. Consumers choose where to shop on the basis of price and expected service rate (the probability of being served). In a one period model, I show that although firms cannot affect consumers' expectations of their service rates by increasing inventory, they can signal higher service rates with higher prices (regardless of whether price or inventory is chosen first). This extra incentive to raise price generates a floor on equilibrium prices and industry profits that exists regardless of the number of firms. When price is set before output, high prices create incentives for firm to hold more inventory. So rational consumers anticipate high priced firms will have higher service rates. Applications of this model to video rental competition and other retail competition are discussed. When output is set before price, high prices act as a signal of high availability. This equilibrium is the unique equilibrium satisfying the never-a-weak-best-response property. Rational consumers anticipate high priced firms will have higher service rates and that firms that deviate to low prices must have changed their availability as well. In a repeated game firms that maintain reputations for higher service rates may earn even higher profits.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1450.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1450

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  1. Horstmann, Ignatius J & MacDonald, Glenn M, 1994. "When Is Advertising a Signal of Product Quality?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 3(3), pages 561-84, Fall.
  2. B. L. Schwartz, 1970. "Optimal Inventory Policies in Perturbed Demand Models," Management Science, INFORMS, vol. 16(8), pages B509-B518, April.
  3. Peters, Michael, 1984. "Bertrand Equilibrium with Capacity Constraints and Restricted Mobility," Econometrica, Econometric Society, vol. 52(5), pages 1117-27, September.
  4. Carlton, Dennis W, 1979. "Contracts, Price Rigidity, and Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 1034-62, October.
  5. Prescott, Edward C, 1975. "Efficiency of the Natural Rate," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1229-36, December.
  6. Noah Gans, 1999. "Customer Learning and Loyalty When Quality is Uncertain," Center for Financial Institutions Working Papers 99-11, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  8. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
  9. Eden, Benjamin, 1990. "Marginal Cost Pricing When Spot Markets Are Complete," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1293-1306, December.
  10. Wolinsky, Asher, 1983. "Prices as Signals of Product Quality," Review of Economic Studies, Wiley Blackwell, vol. 50(4), pages 647-58, October.
  11. Noah Gans, 1999. "Customer Loyalty and Supplier Strategies for Quality Competition," Center for Financial Institutions Working Papers 99-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
  12. Carl Shapiro, 1982. "Consumer Information, Product Quality, and Seller Reputation," Bell Journal of Economics, The RAND Corporation, vol. 13(1), pages 20-35, Spring.
  13. Gould, John P, 1978. "Inventories and Stochastic Demand: Equilibrium Models of the Firm and Industry," The Journal of Business, University of Chicago Press, vol. 51(1), pages 1-42, January.
  14. van Damme, Eric & Hurkens, Sjaak, 1997. "Games with Imperfectly Observable Commitment," Games and Economic Behavior, Elsevier, vol. 21(1-2), pages 282-308, October.
  15. Deneckere, Raymond & Marvel, Howard P & Peck, James, 1996. "Demand Uncertainty, Inventories, and Resale Price Maintenance," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 885-913, August.
  16. Allen, Franklin & Faulhaber, Gerald R, 1988. "Optimism Invites Deception," The Quarterly Journal of Economics, MIT Press, vol. 103(2), pages 397-407, May.
  17. Andrew F. Daughety & Jennifer F. Reinganum, 1991. "Endogenous Availability in Search Equilibrium," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 287-306, Summer.
  18. Shapiro, Carl, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 659-79, November.
  19. Andrew F. Daughety & Jennifer F. Reinganum, 1992. "Search Equilibrium with Endogenous Recall," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 184-202, Summer.
  20. Rogerson, William P, 1987. "The Dissipation of Profits by Brand Name Investment and Entry when Price Guarantees Quality," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 797-809, August.
  21. Benjamin L. Schwartz, 1966. "A New Approach to Stockout Penalties," Management Science, INFORMS, vol. 12(12), pages B538-B544, August.
  22. Smallwood, Dennis E & Conlisk, John, 1979. "Product Quality in Markets Where Consumers are Imperfectly Informed," The Quarterly Journal of Economics, MIT Press, vol. 93(1), pages 1-23, February.
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Citations

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Cited by:
  1. David A. Matsa, 2011. "Running on Empty? Financial Leverage and Product Quality in the Supermarket Industry," American Economic Journal: Microeconomics, American Economic Association, vol. 3(1), pages 137-73, February.
  2. James Jozefowicz & Jason Kelley & Stephanie Brewer, 2008. "New Release: An Empirical Analysis of VHS/DVD Rental Success," Atlantic Economic Journal, International Atlantic Economic Society, vol. 36(2), pages 139-151, June.
  3. Christopher T. Conlon & Julie Holland Mortimer, 2013. "Demand Estimation under Incomplete Product Availability," American Economic Journal: Microeconomics, American Economic Association, vol. 5(4), pages 1-30, November.
  4. Michael A. Arnold & Christine Saliba, 2003. "Price Dispersion in Online Markets: The Case of College Textbooks," Working Papers 03-02, University of Delaware, Department of Economics.
  5. Andrew F. Daughety & Jennifer F. Reinganum, 2007. "Mass Torts and the Incentives for Suit, Settlement, and Trial," Vanderbilt University Department of Economics Working Papers 0713, Vanderbilt University Department of Economics.
  6. Arie Beresteanu, 2004. "Demand Shifts and Second Degree Price discimination - the Impact of DVDs on the Motion Pictures Industry," Econometric Society 2004 North American Winter Meetings 609, Econometric Society.
  7. Stole, Lars A., 2007. "Price Discrimination and Competition," Handbook of Industrial Organization, Elsevier.
  8. Ruiz-Aliseda, Francisco, 2009. "Misinformative advertising," IESE Research Papers D/809, IESE Business School.
  9. Ioannis Ioannou & Julie Holland Mortimer & Richard Mortimer, 2008. "The Effects of Capacity on Sales Under Alternative Vertical Contracts," NBER Working Papers 14611, National Bureau of Economic Research, Inc.
  10. Rosato, Antonio, 2013. "Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs," MPRA Paper 47168, University Library of Munich, Germany.
  11. Ali Yurukoglu, 2012. "Medicare Reimbursements and Shortages of Sterile Injectable Pharmaceuticals," NBER Working Papers 17987, National Bureau of Economic Research, Inc.
  12. Zhenlin Yang & Lydia Gan & Fang-Fang Tang, 2007. "A Study of Pricing Evolution in the Online Toy Market," Economic Growth centre Working Paper Series 0704, Nanyang Technolgical University, School of Humanities and Social Sciences, Economic Growth centre.
  13. Taylor, Curt, 2004. "Privacy and Information Acquisition in Competitive Markets," Berkeley Olin Program in Law & Economics, Working Paper Series qt5hk0k89w, Berkeley Olin Program in Law & Economics.
  14. Michael Sattinger, 2002. "A Queuing Model of the Market for Access to Trading Partners," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(2), pages 533-548, May.
  15. R. Preston McAfee & Hugo Mialon & Sue Mialon, 2005. "Does Large Price Discrimination Imply Great Market Power?," Emory Economics 0525, Department of Economics, Emory University (Atlanta).
  16. Florian Zettelmeyer & Fiona Scott Morton & Jorge Silva-Risso, 2006. "Scarcity Rents in Car Retailing: Evidence from Inventory Fluctuations at Dealerships," NBER Working Papers 12177, National Bureau of Economic Research, Inc.
  17. Arnold, Michael A. & Saliba, Christine, 2011. "Asymmetric capacity constraints and equilibrium price dispersion," Economics Letters, Elsevier, vol. 111(2), pages 158-160, May.

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