Herding versus Hotelling: Market Entry with Costly Information

Abstract:     
Why do businesses such as fast-food restaurants, coffee shops, and hotels cluster? In the classic analysis of Hotelling, firms cluster to attract consumers who have travel costs. We present an alternative model where firms cluster because one firm is free riding on another firm's information about market demand. One consequence of this free riding is that an informed firm might forego a market that it knows to be profitable. Furthermore, an uninformed firm might earn higher profits when research costs are high, because it can credibly commit to ignorance.

Keywords: agglomeration, herding, Hotelling, information

JEL Classifications: L13, D83

Accepted Paper Series