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Dynamic Price Competition with Switching Costs

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  • Fabra, Natalia
  • García, Alfredo

Abstract

We develop a continuous-time dynamic model with switching costs. In a relatively simple Markov Perfect equilibrium, the dominant firm concedes market share by charging higher prices than the smaller firm. In the short-run, switching costs might have two types of anti-competitive effects: first, higher switching costs imply a slower transition to a symmetric market structure and a slower rate of decline for average prices; and second, if firms are sufficiently asymmetric, an increase in switching costs also leads to higher current prices. However, as market structure becomes more symmetric, price competition turns fiercer and in the long-run, switching costs have a pro-competitive effect. From a policy perspective, we conclude that switching costs should only raise concerns in concentrated markets.

Suggested Citation

  • Fabra, Natalia & García, Alfredo, 2012. "Dynamic Price Competition with Switching Costs," CEPR Discussion Papers 8849, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8849
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    References listed on IDEAS

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    1. Yongmin Chen, 1997. "Paying Customers to Switch," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 877-897, 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. Joseph Farrell & Carl Shapiro, 1988. "Dynamic Competition with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 123-137, Spring.
    5. Toker Doganoglu, 2010. "Switching costs, experience goods and dynamic price competition," Quantitative Marketing and Economics (QME), Springer, vol. 8(2), pages 167-205, June.
    6. Biglaiser, Gary & Crémer, Jacques & Dobos, Gergely, 2013. "The value of switching costs," Journal of Economic Theory, Elsevier, vol. 148(3), pages 935-952.
    7. Paul Klemperer, 1987. "Markets with Consumer Switching Costs," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 375-394.
    8. 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.
    9. 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. Fabra, Natalia & García, Alfredo, 2015. "Market structure and the competitive effects of switching costs," Economics Letters, Elsevier, vol. 126(C), pages 150-155.
    2. Luis Cabral, 2016. "Dynamic Pricing in Customer Markets with Switching Costs," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 43-62, April.
    3. Luis Cabral, 2012. "Switching Costs and Equilibrium Prices," Working Papers 12-04, New York University, Leonard N. Stern School of Business, Department of Economics.
    4. Laura Onofri, 2005. "Electricity Market Restructuring and Energy Contracts: A Critical Note on the EU Commission’s NEA Decision," European Journal of Law and Economics, Springer, vol. 20(1), pages 71-85, July.

    More about this item

    Keywords

    continuous-time model; firms' asymmetries; Markov-perfect equilibrium; switching costs;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L41 - Industrial Organization - - Antitrust Issues and Policies - - - Monopolization; Horizontal Anticompetitive Practices

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