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Habit Formation and Oligopolistic Competition

  • Alejandro Tatsuo Moreno


    (Department of Economics and Finance, Universidad de Guanajuato)

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    In this paper I introduce competition in the habit formation literature by extending the idea of habit formation to the characteristics of the products. I model a two-period game in which two rms can enter a market and compete with each other, and individuals’ favorite characteristics in the second period are the characteristics of the product they consumed in the rst period. I nd that if two rms enter the market, they do it sequentially. That is, one rm enters in the rst period and attracts individuals’ preferences to the characteristics of its product, while the other rm enters in the second period and competes for the individuals that have grown to prefer the characteristics of the original product. However, the second rm’s product is similar to the original one, but not exactly the same. The model also applies to habit formation for different markets with characteristics in common. For example, sweetness is a common characteristic of sodas and ice-cream, and consumption of a product in one market affects the preferences for products in the other market. I nd that new rms produce products with similar characteristics not only to a product that has entered the same market, but to products that have entered other markets with characteristics in common. I apply my model to durable goods and nd a new explanation for fashion: rms can take advantage of habit formation by showing their products in the media to generate demand for new durable goods.

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    File Function: Revised version, 2008
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    Paper provided by Universidad de Guanajuato, Department of Economics and Finance in its series Department of Economics and Finance Working Papers with number EC200703.

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    Length: 32 pages
    Date of creation: Dec 2007
    Date of revision: May 2008
    Handle: RePEc:gua:wpaper:ec200703
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    1. Cremer, Helmuth & Thisse, Jacques-Francois, 1994. "Commodity Taxation in a Differentiated Oligopoly," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(3), pages 613-33, August.
    2. Pesendorfer, Wolfgang, 1995. "Design Innovation and Fashion Cycles," American Economic Review, American Economic Association, vol. 85(4), pages 771-92, September.
    3. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
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