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Self-Reinforcing Market Dominance

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  • Daniel Halbheer

    ()
    (Institute for Strategy and Business Economics, University of Zurich)

  • Ernst Fehr

    ()
    (Institute for Empirical Research in Economics, University of Zurich)

  • Lorenz Goette

    ()
    (Center for Behavioral Economics and Decision Making, Federal Reserve Bank of Boston)

  • Armin Schmutzler

    ()
    (Socioeconomic Institute, University of Zurich)

Abstract

Are initial competitive advantages self-reinforcing, so that markets exhibit an endogenous tendency to be dominated by only a few firms? Although this question is of great economic importance, no systematic empirical study has yet addressed it. Therefore, we examine experimentally whether firms with an initial cost advantage are more likely to invest in marginal cost reductions than firms with higher initial costs. We find that the initial competitive advantages are indeed self-reinforcing, but subjects in the role of firms overinvest relative to the Nash equilibrium. However, the pattern of overinvestment even strengthens the tendency towards self-reinforcing cost advantages relative to the theoretical prediction. Further, as predicted by the Nash equilibrium, mean-preserving spreads of the initial cost distribution have no effects on aggregate investments. Finally, investment spillovers reduce investment, and investment is higher than the joint-profit maximizing benchmark for the case without spillovers and lower for the case with spillovers.

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Paper provided by University of Zurich, Institute for Strategy and Business Economics (ISU) in its series Working Papers with number 0094.

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Length: 39
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Handle: RePEc:iso:wpaper:0094

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Keywords: Cost-reducing Investment; Asymmetric Oligopoly; Increasing Dominance; Experimental Study;

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Citations

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Cited by:
  1. Sandra Hanslin, 2008. "The effect of trade openness on optimal government size under endogenous firm entry," SOI - Working Papers 0802, Socioeconomic Institute - University of Zurich.
  2. Daniel Halbheer & Ernst Fehr & Lorenz Goette & Armin Schmutzler, 2007. "Self-Reinforcing Market Dominance," SOI - Working Papers 0711, Socioeconomic Institute - University of Zurich.
  3. Donja Darai & Dario Sacco & Armin Schmutzler, 2009. "Competition and Innovation: An Experimental Investigation," SOI - Working Papers 0608, Socioeconomic Institute - University of Zurich, revised Apr 2007.
  4. Schmutzler, Armin, 2009. "The Relation Between Competition and Investment – Towards a Synthesis," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt8tt4457m, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Dennis Gaertner, 2007. "Monopolistic Screening under Learning By Doing," SOI - Working Papers 0718, Socioeconomic Institute - University of Zurich.
  6. Josef Falkinger, 2008. "Between Agora and Shopping Mall," SOI - Working Papers 0805, Socioeconomic Institute - University of Zurich.
  7. Armin Schmutzler, 2007. "The relation between competition and innovation – Why is it such a mess?," SOI - Working Papers 0716, Socioeconomic Institute - University of Zurich, revised Jan 2010.
  8. Adrian Bruhin, 2008. "Stochastic Expected Utility and Prospect Theory in a Horse Race: A Finite Mixture Approach," SOI - Working Papers 0803, Socioeconomic Institute - University of Zurich.
  9. Dario Sacco & Armin Schmutzler, 2008. "All-Pay Auctions with Negative Prize Externalities: Theory and Experimental Evidence," SOI - Working Papers 0806, Socioeconomic Institute - University of Zurich.
  10. Dennis Gaertner, 2007. "Why Bayes Rules: A Note on Bayesian vs. Classical Inference in Regime Switching Models," SOI - Working Papers 0719, Socioeconomic Institute - University of Zurich.
  11. Johannes Schoder & Peter Zweifel, 2008. "Managed Care Konzepte und Lösungsansätze– Ein internationaler Vergleich aus schweizerischer Sicht," SOI - Working Papers 0801, Socioeconomic Institute - University of Zurich.
  12. Sacco, Dario & Schmutzler, Armin, 2011. "Is there a U-shaped relation between competition and investment?," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 29(1), pages 65-73, January.

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