Price Effects of Entries
- Price Effects of Entries
- Rhee, Ki-Eun
- entry; switching cost
- Issue Date
- Series/Report no.
- KDI Working Paper Series;07-04
- Traditional oligopoly theories of markets where products are differentiated
predict that entry of new firm enhances competition and thereby brings down the
equilibrium market price. These theoretical predictions are, however, often challenged
by contrasting empirical evidence suggesting that price increases with actual entries
(Perloff, Suslow, Sequin (’96); Thomadsen (’05)). We provide a theoretical model in
support of such empirical evidence by incorporating switching costs. Intuitively, if
consumers have to incur costs when they switch products, a monopolist facing potential
entry has incentives to price below the monopoly level and expand its consumer base
pre-entry. By doing so, the incumbent firm can take full advantage of the lock-in effect
post-entry by charging higher prices only to those consumers facing switching costs
instead of directly competing with the entrant.
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