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Market structure and the competitive effects of switching costs

Author

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  • Fabra, Natalia
  • García, Alfredo

Abstract

We revisit the effects of switching costs on dynamic competition. We consider stationary Markovian strategies, with market shares being the state variable, and characterize a relatively simple Markov Perfect pricing equilibrium at which there is switching by some consumers at all times. For the case of low switching costs and infinitely lived consumers, we show that switching costs are pro-competitive in the long-run (steady state) while the overall effect in the short-run (transient state) depends on market structure. In particular, switching costs are anti-competitive in relatively concentrated markets, and pro-competitive otherwise.

Suggested Citation

  • Fabra, Natalia & García, Alfredo, 2015. "Market structure and the competitive effects of switching costs," Economics Letters, Elsevier, vol. 126(C), pages 150-155.
  • Handle: RePEc:eee:ecolet:v:126:y:2015:i:c:p:150-155
    DOI: 10.1016/j.econlet.2014.12.008
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    References listed on IDEAS

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    1. Natalia Fabra & Alfredo García, 2015. "Dynamic Price Competition with Switching Costs," Dynamic Games and Applications, Springer, vol. 5(4), pages 540-567, December.
    2. Andrew Rhodes, 2014. "Re-examining the effects of switching costs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 57(1), pages 161-194, September.
    3. Luís Cabral, 2011. "Dynamic Price Competition with Network Effects," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 83-111.
    4. Cabral, Luís M B, 2012. "Switching Costs and Equilibrium Prices," CEPR Discussion Papers 8970, C.E.P.R. Discussion Papers.
    5. Joseph Farrell & Carl Shapiro, 1988. "Dynamic Competition with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 123-137, Spring.
    6. Farrell, Joseph & Klemperer, Paul, 2007. "Coordination and Lock-In: Competition with Switching Costs and Network Effects," Handbook of Industrial Organization, in: Mark Armstrong & Robert Porter (ed.), Handbook of Industrial Organization, edition 1, volume 3, chapter 31, pages 1967-2072, Elsevier.
    7. Toker Doganoglu, 2010. "Switching costs, experience goods and dynamic price competition," Quantitative Marketing and Economics (QME), Springer, vol. 8(2), pages 167-205, June.
    8. Paul Klemperer, 1987. "Markets with Consumer Switching Costs," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 375-394.
    9. J. Miguel Villas‐Boas, 2006. "Dynamic Competition with Experience Goods," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 15(1), pages 37-66, March.
    10. V. Brian Viard, 2007. "Do switching costs make markets more or less competitive? The case of 800-number portability," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 146-163, March.
    11. Mengze Shi & Jeongwen Chiang & Byong-Duk Rhee, 2006. "Price Competition with Reduced Consumer Switching Costs: The Case of "Wireless Number Portability" in the Cellular Phone Industry," Management Science, INFORMS, vol. 52(1), pages 27-38, January.
    12. Paul Klemperer, 1987. "The Competitiveness of Markets with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 18(1), pages 138-150, Spring.
    13. Dockner,Engelbert J. & Jorgensen,Steffen & Long,Ngo Van & Sorger,Gerhard, 2000. "Differential Games in Economics and Management Science," Cambridge Books, Cambridge University Press, number 9780521637329.
    14. Klemperer, Paul D, 1987. "Entry Deterrence in Markets with Consumer Switching Costs," Economic Journal, Royal Economic Society, vol. 97(388a), pages 99-117, Supplemen.
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    Cited by:

    1. Janssen, Aljoscha, 2020. "Price Dynamics of Swedish Pharmaceuticals," Working Paper Series 1325, Research Institute of Industrial Economics.
    2. Ruiz-Aliseda, Francisco, 2016. "When do switching costs make markets more or less competitive?," International Journal of Industrial Organization, Elsevier, vol. 47(C), pages 121-151.
    3. Shy, Oz & Stenbacka, Rune & Zhang, David Hao, 2016. "History-based versus uniform pricing in growing and declining markets," International Journal of Industrial Organization, Elsevier, vol. 48(C), pages 88-117.
    4. Janssen, Aljoscha, 2020. "Switching Costs, Brand Premia and Behavioral Pricing in the Pharmaceutical Market," Working Paper Series 1317, Research Institute of Industrial Economics.
    5. Miah, Mohammad Dulal & Kabir, Md. Nurul & Safiullah, Md, 2020. "Switching costs in Islamic banking: The impact on market power and financial stability," Journal of Behavioral and Experimental Finance, Elsevier, vol. 28(C).
    6. Siciliani, Paolo & Beckert, Walter, 2017. "Spatial models of heterogeneous switching costs," Bank of England working papers 689, Bank of England.

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    More about this item

    Keywords

    Switching costs; Continuous-time model; Markov-perfect equilibrium; Differential games; Market concentration;
    All these keywords.

    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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