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A Framework for Dynamic Oligopoly in Concentrated Industries

  • Vivek Farias

    (MIT)

  • Bar Ifrach

    (Columbia Business School)

  • Gabriel Weintraub

    (Columbia University)

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    We consider dynamic oligopoly models in the spirit of Ericson and Pakes (1995). We introduce a new computationally tractable model for industries with a few dominant firms and many fringe firms. This is a prevalent market structure in consumer and industrial goods. In our model, firms keep track of the detailed state of dominant firms and of few moments of the distribution that describes the states of fringe firms. Based on this idea we introduce a new equilibrium concept that we call moment-based Markov equilibrium (MME). MME is behaviorally appealing and computationally tractable. However, MME can suffer from an important pitfall. Because moments may not summarize all payoff relevant information, MME strategies may not be optimal. We propose different approaches to overcome this difficulty with varying degrees of restrictions on the model primitives and strategies. Our first approach introduces models for which moments summarize all payoff relevant history and therefore for which MME strategies are optimal. The second approach restrict fringe firm strategies so that again moments become sufficient statistics. The third approach does not impose such restrictions, but introduces a computational error bound to asses the degree of sub-optimality of MME strategies. This bound allows to evaluate whether a finer state aggregation is necessary, for example by adding more moments. We provide computational experiments to show that our algorithms and error bound work well in practice for important classes of models. We also show that, cumulatively, fringe firms discipline dominant firms to behave more competitively, and that ignoring fringe firms in counterfactual analysis may lead to incorrect conclusions. Our model significantly extends the class of dynamic oligopoly models that can be studied computationally. In addition, our methods can also be used to improve approximations in other contexts such as dynamic industry models with an infinite number of heterogeneous firms and an aggregate shock; stochastic growth models in the spirit of Krusell and Smith (1998); and dynamic models with forward-looking consumers.

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    File URL: https://www.economicdynamics.org/meetpapers/2012/paper_505.pdf
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    Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 505.

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    Date of creation: 2012
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    Handle: RePEc:red:sed012:505
    Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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    Web page: http://www.EconomicDynamics.org/society.htm
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    1. Andrew Sweeting, 2007. "Dynamic Product Repositioning in Differentiated Product Markets: The Case of Format Switching in the Commercial Radio Industry," NBER Working Papers 13522, National Bureau of Economic Research, Inc.
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