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Markov perfect industry dynamics with many firms

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  • Gabriel Y. Weintraub
  • C. Lanier Benkard
  • Benjamin Van Roy
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    Abstract

    We propose an approximation method for analyzing Ericson and Pakes (1995)-style dynamic models of imperfect competition. We develop a simple algorithm for computing an "oblivious equilibrium," in which each firm is assumed to make decisions based only on its own state and knowledge of the long run average industry state, but where firms ignore current information about competitors' states. We prove that, as the market becomes large, if the equilibrium distribution of firm states obeys a certain "lighttail" condition, then oblivious equilibria closely approximate Markov perfect equilibria. We develop bounds that can be computed to assess the accuracy of the approximation for any given applied problem. Through computational experiments, we find that the method often generates useful approximations for industries with hundreds of firms and in some cases even tens of firms.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2005-23.

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    Date of creation: 2005
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    Handle: RePEc:fip:fedfwp:2005-23

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    Keywords: Competition ; Econometric models;

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    References

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    1. Besanko, David & Doraszelski, Ulrich & Kryukov, Yaroslav & Satterthwaite, Mark, 2007. "Learning-by-Doing, Organizational Forgetting and Industry Dynamics," CEPR Discussion Papers 6160, C.E.P.R. Discussion Papers.
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    3. Minjae Song, 2006. "A Dynamic Analysis of Cooperative Research in the Semiconductor Industry," 2006 Meeting Papers 468, Society for Economic Dynamics.
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    8. Caplin, Andrew & Nalebuff, Barry, 1991. "Aggregation and Imperfect Competition: On the Existence of Equilibrium," Econometrica, Econometric Society, vol. 59(1), pages 25-59, January.
    9. C. Lanier Benkard, 2004. "A Dynamic Analysis of the Market for Wide-Bodied Commercial Aircraft," Review of Economic Studies, Wiley Blackwell, vol. 71, pages 581-611, 07.
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    11. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
    12. de Roos, Nicolas, 2004. "A model of collusion timing," International Journal of Industrial Organization, Elsevier, vol. 22(3), pages 351-387, March.
    13. Patricia Langohr, 2003. "Competitive Convergence and Divergence: Capability and Position Dynamics," Computing in Economics and Finance 2003 229, Society for Computational Economics.
    14. Shaked, Avner & Sutton, John, 1987. "Product Differentiation and Industrial Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 36(2), pages 131-46, December.
    15. Kenneth Judd & Karl Schmedders & Sevin Yeltekin, . "Optimal Rules for Patent Races," GSIA Working Papers 2006-E37, Carnegie Mellon University, Tepper School of Business.
    16. Klette, Tor Jakob & Kortum, Samuel, 2002. "Innovating Firms and Aggregate Innovation," Memorandum 02/2002, Oslo University, Department of Economics.
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    18. Ariel Pakes, 2000. "A Framework for Applied Dynamic Analysis in I.O," NBER Working Papers 8024, National Bureau of Economic Research, Inc.
    19. Berry, Steven & Pakes, Ariel, 1993. "Some Applications and Limitations of Recent Advances in Empirical Industrial Organization: Merger Analysis," American Economic Review, American Economic Association, vol. 83(2), pages 247-52, May.
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    21. C. Lanier Benkard, 2004. "A Dynamic Analysis of the Market for Wide-Bodied Commercial Aircraft," Review of Economic Studies, Oxford University Press, vol. 71(3), pages 581-611.
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    Cited by:
    1. Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Computational Methods for Oblivious Equilibrium," Research Papers 1969, Stanford University, Graduate School of Business.
    2. Xiao, Junji, 2008. "Markov Perfect Equilibrium in the US digital camera market," International Journal of Industrial Organization, Elsevier, vol. 26(5), pages 1233-1249, September.

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