Price Competition in Markets with Customer Testing: The Captive Customer Effect
Heidrun C. Hoppe-Wewetzer
University of Hannover - Department of Economics; and CEPR
University of Hamburg - Department of Economics
CEPR Discussion Paper No. DP6229
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.
Number of Pages in PDF File: 31
Keywords: Hotelling, Iterated elimination of strictly dominated strategies, Mixed strategy, Price competition, Testing
JEL Classification: D83, G21, L13working papers series
Date posted: May 22, 2008
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