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Dynamic Price Competition With Price Adjustment Costs And Product Differentiation

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  • Vernasca, Gianluigi

    (Department of Economics, University of Warwick)

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    Abstract

    We study a discrete time dynamic game of price competition with spatially differentiated products and price adjustment costs. We characterise the Markov perfect and the open-loop equilibrium of our game. We find that in the steady state Markov perfect equilibrium, given the presence of adjustment costs, equilibrium prices are always higher than prices at the repeated static Nash solution, even though, adjustment costs are not paid in steady state.This is due to intertemporal strategic complementarity in the strategies of the firms and from the fact that the cost of adjusting prices adds credibility to high price equilibrium strategies. On the other hand, the stationary open-loop equilibrium coincides always with the static solution. Furthermore, in contrast to continuous time games, we show that the stationary Markov perfect equilibrium converges to the static Nash equilibrium when adjustment costs tend to zero. Moreover, we obtain the same convergence result when adjustment costs tend to infinity.

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    File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2008/twerp681.pdf
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    Bibliographic Info

    Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 681.

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    Length: 24 pages
    Date of creation: 2003
    Date of revision:
    Handle: RePEc:wrk:warwec:681

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    Web page: http://www2.warwick.ac.uk/fac/soc/economics/
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    Related research

    Keywords: price adjustment costs ; difference game ; Markov perfect equilibrium ; Open-loop equilibrium;

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    1. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," Econometrica, Econometric Society, vol. 56(3), pages 571-99, May.
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    3. Karp, Larry S. & Perloff, Jeffrey M., 1993. "Open-loop and feedback models of dynamic oligopoly," International Journal of Industrial Organization, Elsevier, vol. 11(3), pages 369-389, September.
    4. Slade, Margaret E., 1999. "Sticky prices in a dynamic oligopoly: An investigation of (s,S) thresholds," International Journal of Industrial Organization, Elsevier, vol. 17(4), pages 477-511, May.
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    12. AMIR, Rabah, 2001. "Stochastic games in economics and related fields: an overview," CORE Discussion Papers 2001060, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    13. Piga, Claudio A. G., 2000. "Competition in a duopoly with sticky price and advertising," International Journal of Industrial Organization, Elsevier, vol. 18(4), pages 595-614, May.
    14. Lapham, Beverly & Ware, Roger, 1994. "Markov puppy dogs and related animals," International Journal of Industrial Organization, Elsevier, vol. 12(4), pages 569-593, December.
    15. Reynolds, Stanley S., 1991. "Dynamic oligopoly with capacity adjustment costs," Journal of Economic Dynamics and Control, Elsevier, vol. 15(3), pages 491-514, July.
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    17. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May.
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