Do Switching Costs Make Markets Less Competitive?
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
Günter J. Hitsch
University of Chicago - Booth School of Business
Peter E. Rossi
University of California, Los Angeles (UCLA) - Anderson School of Management
The conventional wisdom in economic theory holds that switching costs make markets less competitive. This paper challenges this claim. We find that steady-state equilibrium prices may fall as switching costs are introduced into a simple model of dynamic price competition that allows for differentiated products and imperfect lock-in. To assess whether this finding is of empirical relevance, we consider a more general model with heterogeneous consumers. We calibrate this model with data from a frequently purchased packaged goods market where consumers exhibit inertia in their brand choices, a behavior consistent with switching costs. We estimate the level of switching costs from the brand choice behavior in this data. At switching costs of the order of magnitude found in our data, prices are lower than without switching costs.
Number of Pages in PDF File: 47
Keywords: switching costs, dynamic model, brand loyalty, state dependence
JEL Classification: D1, D4, L1, M3
Date posted: June 13, 2006 ; Last revised: February 6, 2009
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