What happens if one rm deviates and charges some p 1

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Unformatted text preview: rms at PC outcome. What happens if one firm deviates, and charges some p 1 such that 0 < p 1 < c ? Consumers at this store? Consumers at other stores? How will other stores respond? By iterating this reasoning .... EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, Lecture 12:Institute and price dispersion California Search of Technology) September 9, 2011 6 / 25 Outline Now start at “monopoly outcome”, where all firms are charging u . What are consumers’ purchase rules? Do firms want to undercut? Given consumer behavior, what do they gain? Role for advertising? P. Diamond (1971), “A Theory of Price Adjustment”, Journal of Economic Theory EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, Lecture 12:Institute and price dispersion California Search of Technology) September 9, 2011 7 / 25 Outline Remarks Diamond result quite astounding, since it suggests PC result is “knife-edge” case. But still doesn’t explain price dispersion Assume consumers differ in search costs Two types of consumers: “natives” are perfectly informed about prices, but “tourists” are not. EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, Lecture 12:Institute and price dispersion California Search of Technology) September 9, 2011 8 / 25 Outline Tourist-natives model Tourists and natives, in proportions 1 − α and α. L total consumers (so αL natives, and (1 − α)L tourists). Tourists buy one unit as long as p ≤ u , but natives always shop at the cheapest store. Each of n identical firms has U-shaped AC curve Each firm gets equal number of tourists cheapest store. (1−α)L n ; natives always go to Consider world in which all firms start by setting p c = minq AC (q ). Note that deviant store always wants to price higher. Demand curve for a deviant firm is kinked (graph). Deviant firm sells exclusively to tourists. EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, Lecture 12:Institute and price dispersion California Search of Technology) September 9, 2011 9 / 25 Outline Deviant firm will always charge u . Only tourists shop at this store. If charge above u , no demand. If below u , then profits increase by charing u . First case: many informed consumers (α large) Number q u ≡ (1−α)L n of tourists at each store so small that u < AC (q u ). In free-entry equilibrium, then, all firms charge p c , and produce the same quantity L/n. If enough informed consumers, competitive equilibrium can obtain (not surprising) EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, Lecture 12:Institute and price dispersion California Search of Technology) September 9, 2011 10 / 25 Outline Second case: few informed consumers (α small) Assume enough tourists so that u > AC (q u ). But now: hi-price firms making positive profits, while lo-price firms making (at most) zero profits. Not stable. In order to have equilibrium: ensure th...
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