Consumer Inertia and Market Power

Abstract

We study the pricing decisions of firms in the presence of consumer inertia. Inertia, which can arise from habit formation, brand loyalty, and switching costs, generates dynamic pricing incentives. These incentives mediate the impact of competition on market power in oligopoly settings. For example, dynamic incentives can limit the equilibrium price effects of a horizontal merger. However, the way that the merger is implemented---whether the merged firm maintains separate brands or consolidates them into a single entity---can have large effects on equilibrium prices in the presence of inertia. We develop an empirical oligopoly model to estimate consumer inertia and dynamic pricing incentives using market-level data. We apply the model to a hypothetical merger of retail gasoline companies. Our analysis shows how the static model predictions can diverge meaningfully from those obtained while accounting for dynamics.

Keywords: Consumer Inertia, Market Power, Dynamic Competition, Demand Estimation

JEL Classification: D12, D43, L13, L41, L81