Working Paper: CEPR ID: DP6229
Authors: Heidrun C. Hoppe; Ulrich Lehmann-Grube
Abstract: We introduce product differentiation into the analysis of price competition in markets where suppliers test customers in order to assess whether they will pay for received goods or services. We find that, if the degree of differentiation is sufficiently high, suppliers may improve the average probability that their clientele will pay by charging higher prices. This helps suppliers to sustain high prices in equilibrium. Moreover, endogenizing locations in product space, we demonstrate that the high price level can be implemented in a pure-strategy subgame-perfect equilibrium with a high degree of differentiation. This is in contrast to the original Hotelling model with linear travel costs where a pure-strategy subgame-perfect equilibrium fails to exist.
Keywords: Hotelling; Iterated elimination of strictly dominated strategies; Mixed strategy; Price competition; Testing
JEL Codes: D83; G21; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| presence of captive customers (D16) | supplier pricing strategies (L11) |
| higher prices (D49) | average profitability of the supplier (D22) |
| higher prices (D49) | reduction in proportion of less desirable captive customers (D16) |
| captive customer effect (D43) | sustain high prices in equilibrium (D41) |