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The Effect of a Credit Crunch on Equilibrium Market Structure

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  • Watzinger, Martin

Abstract

This article examines the impact of a credit crunch on market structure. We construct and simulate a dynamic model of a duopolistic industry in which firms' investments in capacity are constrained by the availability of credit. In such an industry, the dynamic interaction of credit limits and the competitive responses of firms turn out to be a powerful transmission mechanism by which the effects of shocks persist and are amplified. We show that a small, temporary shock to one firm's capacity can lead to its market exit, even if it is equally productive as the remaining incumbent. Consequently, if a recession is accompanied by a credit crunch, its cleansing effect might lead to monopolization of markets and welfare losses.

Suggested Citation

  • Watzinger, Martin, 2016. "The Effect of a Credit Crunch on Equilibrium Market Structure," Munich Reprints in Economics 43527, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenar:43527
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    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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