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Simple Markov-perfect industry dynamics

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  • Jaap H. Abbring
  • Jeffrey R. Campbell
  • Nan Yang

Abstract

This paper develops a tractable model for the computational and empirical analysis of infinite-horizon oligopoly dynamics. It features aggregate demand uncertainty, sunk entry costs, stochastic idiosyncratic technological progress, and irreversible exit. We develop an algorithm for computing a symmetric Markov-perfect equilibrium quickly by finding the fixed points to a finite sequence of low-dimensional contraction mappings. If at most two heterogenous firms serve the industry, the result is the unique "natural" equilibrium in which a high profitability firm never exits leaving behind a low profitability competitor. With more than two firms, the algorithm always finds a natural equilibrium. We present a simple rule for checking ex post whether the calculated equilibrium is unique, and we illustrate the model's application by assessing how price collusion impacts consumer and total surplus in a market for a new product that requires costly development. The results confirm Fershtman and Pakes' (2000) finding that collusive pricing can increase consumer surplus by stimulating product development. A distinguishing feature of our analysis is that we are able to assess the results' robustness across hundreds of parameter values in only a few minutes on an off-the-shelf laptop computer.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-2010-21.

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Date of creation: 2010
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Handle: RePEc:fip:fedhwp:wp-2010-21

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Keywords: Markov processes;

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Cited by:
  1. Allen Tran, 2014. "The Aggregate Impact Of Online Retail," Working Papers 14-23, Center for Economic Studies, U.S. Census Bureau.
  2. Joao Macieira, 2010. "Oblivious Equilibrium in Dynamic Discrete Games," 2010 Meeting Papers 680, Society for Economic Dynamics.

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