We develop a simple model of retail competition in which retailers select prices and investments in cost reduction. Unable to observe firms' current prices prior to costly search, consumers monitor firms' historic pricing behavior. An equilibrium is constructed in which several identical firms enter and then engage in a phase of vigorous price competition, corresponding to a battle for low-price reputations. This phase is concluded with a "shakeout," as a low-price, low-cost firm comes to dominate the market while other firms lose market share. A central feature of the equilibrium is that low prices are complementary to large investments in cost reduction. Even though the dominant firm's price rises through time, and initially may be below marginal cost, we argue that an interpretation of predatory pricing may be appropriate, since the dominant firm is also the most-efficient (lowest-cost) firm in the market.
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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number
1115.
Length: Date of creation: Oct 1993 Date of revision: Handle: RePEc:nwu:cmsems:1115
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Varian, Hal R, 1980.
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American Economic Review,
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[Downloadable!] (restricted)
Kreps, David M & Wilson, Robert, 1982.
"Sequential Equilibria,"
Econometrica,
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[Downloadable!] (restricted)
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Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Jeffrey R. Campbell & Hugo Hopenhayn, 2003.
"Market size matters,"
Working Paper Series
WP-03-12, Federal Reserve Bank of Chicago.
[Downloadable!]
Other versions:
Jeffrey R. Campbell & Hugo A. Hopenhayn, 2002.
"Market Size Matters,"
NBER Working Papers
9113, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)