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Dynamic Retail Price and Investment Competition


  • Kyle Bagwell


We develop a simple model of retail competition in which retailers select prices and investments in cost reduction. Unable to observe firms' current prices prior to costly search, consumers monitor firms' historic pricing behavior. An equilibrium is constructed in which several identical firms enter and then engage in a phase of vigorous price competition, corresponding to a battle for low-price reputations. This phase is concluded with a "shakeout," as a low-price, low-cost firm comes to dominate the market while other firms lose market share. A central feature of the equilibrium is that low prices are complementary to large investments in cost reduction. Even though the dominant firm's price rises through time, and initially may be below marginal cost, we argue that an interpretation of predatory pricing may be appropriate, since the dominant firm is also the most-efficient (lowest-cost) firm in the market.

Suggested Citation

  • Kyle Bagwell, 1993. "Dynamic Retail Price and Investment Competition," Discussion Papers 1115, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  • Handle: RePEc:nwu:cmsems:1115

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    References listed on IDEAS

    1. Kreps, David M & Wilson, Robert, 1982. "Sequential Equilibria," Econometrica, Econometric Society, vol. 50(4), pages 863-894, July.
    2. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-659, September.
    3. Kyle Bagwell & Garey Ramey, 1992. "The Diamond Paradox: A Dynamic Resolution," Discussion Papers 1013, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Bagwell, Kyle, 1992. "A Model of Competitive Limit Pricing," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 1(4), pages 585-606, Winter.
    5. Kyle Bagwell, 1987. "Introductory Price as a Signal of Cost in a Model of Repeat Business," Review of Economic Studies, Oxford University Press, vol. 54(3), pages 365-384.
    6. Stone, Kenneth E., 1991. "Competing with the Mass Merchandisers," Staff General Research Papers Archive 11230, Iowa State University, Department of Economics.
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    Cited by:

    1. Bernstein, Fernando & Federgruen, Awi, 2004. "Comparative statics, strategic complements and substitutes in oligopolies," Journal of Mathematical Economics, Elsevier, vol. 40(6), pages 713-746, September.
    2. Dalida Kadyrzhanova & Antonio Falato, 2008. "Optimal CEO Incentives and Industry Dynamics," 2008 Meeting Papers 880, Society for Economic Dynamics.
    3. Emanuele Deligia, 2006. "Innovation And Finance: The Theoretical Links," Economia, Societa', e Istituzioni, Dipartimento di Economia e Finanza, LUISS Guido Carli, vol. 0(1).
    4. Luis M. B. Cabral, 2000. "Dynamic Competition with No Efficiency Effect," Econometric Society World Congress 2000 Contributed Papers 0512, Econometric Society.
    5. Jeffrey R. Campbell & Hugo A. Hopenhayn, 2005. "Market Size Matters," Journal of Industrial Economics, Wiley Blackwell, vol. 53(1), pages 1-25, March.
    6. Susan Athey & Armin Schmutzler, 1999. "Innovation and the Emergence of Market Dominance," Working papers 99-18, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Cabral, Luis M. B., 2002. "Increasing Dominance with No Efficiency Effect," Journal of Economic Theory, Elsevier, vol. 102(2), pages 471-479, February.
    8. Emek Basker & Shawn Klimek & Pham Hoang Van, 2008. "Supersize It: The Growth of Retail Chains and the Rise of the "Big Box" Retail Format," Working Papers 08-23r, Center for Economic Studies, U.S. Census Bureau, revised Sep 2011.
    9. Emin M. Dinlersoz, 2000. "Firm Organization and Retail Industry Dynamics," Econometric Society World Congress 2000 Contributed Papers 0005, Econometric Society.
    10. Ronald S. Jarmin & Shawn D. Klimek & Javier Miranda, 2009. "The Role of Retail Chains: National, Regional and Industry Results," NBER Chapters,in: Producer Dynamics: New Evidence from Micro Data, pages 237-262 National Bureau of Economic Research, Inc.
    11. Harrington, Joseph Jr. & Chang, Myong-Hun, 2005. "Co-evolution of firms and consumers and the implications for market dominance," Journal of Economic Dynamics and Control, Elsevier, vol. 29(1-2), pages 245-276, January.
    12. Holmes, Thomas J, 2001. "Bar Codes Lead to Frequent Deliveries and Superstores," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 708-725, Winter.
    13. Dalida Kadyrzhanova, 2005. "Predatory Governance," Computing in Economics and Finance 2005 421, Society for Computational Economics.

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