Working Paper: CEPR ID: DP8849
Authors: Natalia Fabra; Alfredo Garcia
Abstract: We develop a continuous-time dynamic model with switching costs. In a relatively simple Markov Perfect equilibrium, the dominant firm concedes market share by charging higher prices than the smaller firm. In the short-run, switching costs might have two types of anti-competitive effects: first, higher switching costs imply a slower transition to a symmetric market structure and a slower rate of decline for average prices; and second, if firms are sufficiently asymmetric, an increase in switching costs also leads to higher current prices. However, as market structure becomes more symmetric, price competition turns fiercer and in the long-run, switching costs have a pro-competitive effect. From a policy perspective, we conclude that switching costs should only raise concerns in concentrated markets.
Keywords: Continuous-time model; Firms; Asymmetries; Markov-perfect equilibrium; Switching costs
JEL Codes: C61; L13; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher switching costs (L15) | higher prices (D49) |
| Higher switching costs (L15) | slower transition to a symmetric market structure (D49) |
| slower transition to a symmetric market structure (D49) | slower rate of decline for average prices (E30) |
| Market structure becomes more symmetric (D49) | lower prices (P22) |
| Higher switching costs (L15) | anti-competitive effects (L41) |
| As market structure becomes more symmetric (D49) | pro-competitive effect (L49) |