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Self-Reinforcing Market Dominance

  • Daniel Halbheer

    ()

    (Socioeconomic Institute, University of Zurich)

  • Ernst Fehr

    ()

    (Institute for Empirical Research in Economics, University of Zurich)

  • Lorenz Goette

    ()

    (Center for Behavioral Economics and Decision Making, Federal Reserve Bank of Boston)

  • Armin Schmutzler

    ()

    (Socioeconomic Institute, University of Zurich)

Are initial competitive advantages self-reinforcing, so that markets exhibit an endogenous tendency to be dominated by only a few firms? Although this question is of great economic importance, no systematic empirical study has yet addressed it. Therefore, we examine experimentally whether firms with an initial cost advantage are more likely to invest in cost reductions than firms with higher initial costs. Wefind that the initial competitive advantages are indeed self-reinforcing, but subjects in the role of firms overinvest relative to the Nash equilibrium. However, the pattern of overinvestment even strengthens the tendency towards self-reinforcing cost advantages relative to the theoretical prediction. Further, as predicted by the Nash equilibrium, aggregate investment is not affected by the initial efficiency distribution. Finally, investment spillovers reduce investment, and investment is higher than the joint-profit maximizing benchmark for the case without spillovers and lower for the case with spillovers.

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File URL: http://www.econ.uzh.ch/static/wp_soi/wp0711.pdf
File Function: First version, 2007
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Paper provided by Socioeconomic Institute - University of Zurich in its series SOI - Working Papers with number 0711.

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Length: 34 pages
Date of creation: Aug 2007
Date of revision:
Publication status: published in Games and Economic Behavior 67, pp. 481-502, 2009
Handle: RePEc:soz:wpaper:0711
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