Volume 16, Issue 1:

De Bijl, Paul W. J

"Entry deterrence and signaling in markets for search goods"

JEL codes: D43; D82; L13; L15
Keywords: Entry barriers; Search goods; Search costs; Signaling; Common information

Abstract: This paper studies entry in markets for search goods. Signaling through prices is studied in both when an entrant's quality is private information and when it is common knowledge to the entrant and incumbent. When consumers visit a store, they are assumed to observe quality and have the option of continuing to search but at a cost. When search costs are low, an entrant can signal high quality by setting a sufficiently high price, so that consumers who find out that its quality is low visit the incumbent. Entry may be facilitated when search costs are sufficiently low, or when the incumbent knows the quality of the entrant's product.

Lommerud, Kjell Erik and Sørgard, Lars

"Merger and product range rivalry"

JEL codes: L13, L41
Keywords: Merger policy; Product differentiation; Socially optimal product variety

Abstract: The received literature concludes that if scale economies are absent, mergers are often unprofitable under Cournot competition, but always profitable under Bertrand. In a linear demand model with three firms initially, where there are two merger candidates, we show that results will change if we introduce the number of brands as a choice variable. When a non-participating firm responds to a merger by introducing a new brand, the merger would often have been welfare improving, but it is never profitable. It will not be socially beneficial, though, unless the fixed cost of marketing a brand is high and non-sunk and brands are close substitutes.

Ellingsen, Tore

"Price signals quality: The case of perfectly inelastic demand"

JEL codes: L15, D82
Keywords: Pricing; Signalling; Product quality; Separating equilibrium

Abstract: This paper considers the pricing decision by a seller who has private information about quality. Demand is perfectly inelastic (rectangular). For example, there may be a single buyer who wants exactly one unit and whose valuation is known by the seller. It is noted that, contrary to widespread belief, separating equilibria do exist in this model, allowing some trade of high quality products even when the average quality is low. Moreover, by slightly perturbing demand, we can use standard equilibrium outcome. Since the chosen outcome has a very simple structure regardless of the number of quality levels, this model could be a useful workhorse in applications.

Hendel, Igal and Neiva de Figuiredo, John

"Product differentiation and endogenous disutility"

JEL codes: L1; M3
product differentiation; general purposeness; product design

        Abstract: This paper models the choice of degree of focus (or general purposeness) available to firms by endogenizing transportation costs in an address model of horrizontal differentiation. The formulation is in three stages: entry, forcus or design competition and price competition. The strategic effect of product design is analyzed. The equilibrium level of general purposeness is shown to depend critically on 'neighbor exclusivity'. The latter and, more generally, market structure and product diversity are shown to depend on the cost of producing general purpose products. If general purposeness is 'free' - to design and produce - only two firms enter the market and set large transportation costs, underproviding product diversity.

Constantatos, Christos and Perrakis, Stylianos

"Vertical differentiation: entry and market coverage with multiproduct firms"

JEL codes: L12
Keywords: Entry; Market coverage; Monopoly; Vertical differentiation

Abstract: We consider a multiproduct monopoly producing many qualities of the same product in a market where the consumers' income distribution is sufficiently wide so as to rule out the case of a natural monopoly. In this context, Mussa and Rosen (1978, Journal of Economic Theory 18, 301-317) show that a protected monopolist may decide to leave part of the market unserved. Here, we examine whether entry threats are sufficient to induce complete market coverage. We assume that the number of qualities in the incumbent's product line is endogenously determined and that both the incumbent and the entrant face the same fixed cost of introducing a new quality. Thus, an increase in the fixed cost does not necessarily make entry more difficult. As it turns out, there are disjoint intervals of the fixed cost for which the monopolist's optimal policy is sufficient to deter entry even if it implies that part of the market remains uncovered. When entry is not blockaded, the monopolist may find it profitable to react to entry threats by upgrading his intermediate qualities. The resulting actual entry would have resulted in complete market coverage, potential entry may not improve, and in many cases may worsen, the extent of market coverage

Gabrielsen, Tommy Staahl

"Equilibrium retail distribution systems"

JEL codes: L12, L42
Keywords: Retail distribution; Exclusive dealing; Common agency

Abstract: I analyze producers' choices of optimal distribution systems in a setting with two producers of differentiated products and two identical retailers. Producers may choose to have a single common retailer or one exclusive retailer each. In an infinite horizon model the producers initially pick a distribution system, and once this decision is made producers can be sustained if waiting costs are low enough, and welfare is reduced as compared with when producers have exclusive dealers.

Hughes, John S. and Kao, Jennifer L.

"Strategic forward contracting and observability"

JEL codes: L13
Keywords: Forward contracts; Commitment; Hedging; Observability

Abstract: Recently, Allaz (1992) characterized strategic and hedging incentives for entering forward contracts in a two-stage duopoly setting under the implicit assumption that positions in forward contracts are publicly observable. However, credible disclosure of such positions is, at best, costly and subject to noise. Our purpose in this paper is to examine the effects of observability on the interdependency between strategic and hedging behavior. First, focusing on an Allaz-type setting with Cournot conjectures at both stages, we show that if forward positions are unobservable and the hedging motive is not present, i.e., risk neutrality, then the strategic incentive disappears. In fact, contrary to Allaz, each producer strictly prefers not to engage in forward contracting. However, given that a hedging motive is present, we show that motive by their rival. In this case, they behave strategically notwithstanding the absence of observability.

We then extend the analysis beyond Allaz's setting to consider cases in which uncertainty relates to cost and resolution of uncertainty follows rather than precedes production. When cost uncertainty is resolved before production decisions are made, we show that a hedging motive induces forward positions in the opposite direction to those motivated by strategic incentives and more so in the absence of observability. Lastly, when cost uncertainty is resolved after production, we show that the hedging motive disappears and producers only engage in forward contracting when their positions are observable.

Our analysis is relevant to financial reporting practices governing the disclosure of forward contracts.