Three essays on horizontal product differentiation and price dispersion

Bernd Jost

Publication: ThesisDoctoral thesis


The first essay provides an introduction into the literature of spatial competition models and studies their predictions on the degree of horizontal product differentiation. For this purpose a selection of articles, mainly from the game theoretical strand of the literature, is re-examined in which each model extends and modifies basic parameters of the original model of Hotelling (1929). <br/>The literature survey emphasizes that markets consisting of intersecting roads represent a particular fruitful subject of future research. The nature of competition in this market setting is different compared to the linear city exemplified by the importance of asymmetrical location patterns. Consequently, the strategic interaction, firms' profit-maximizing behavior and potential equilibrium outcomes under sequential entry in a market with intersecting roads remain to be an interesting field <br/>to study. <br/> <br/>The second essay addresses this research gap and based on the work of Anderson (1987) studies a two-stage market entry game in a spatially extended Hotelling's <br/>duopoly. Particularly, the effect of a demand dependent centrality bonus Z distributed in the middle of the linear city is examined on the reaction functions of <br/>an incumbent firm and the strategic entry decision of an entrant firm. A solution is provided for an entry accommodating scenario where both players optimize profits <br/>over their strategic variables and the center Z is taken by the incumbent firm. The results further suggest that the entrant is not capable of capturing Z. In addition, <br/>the model implies a lower degree of product differentiation as Z increases. A comparison with the literature shows that these results are well in line with Anderson's model for Z = 0. In a business strategy view the outcome supports the <br/>thesis of Gelman & Salop (1983), coined by the term 'judo economics', since the entrant earns highest profits by committing himself to a distant location and charging <br/>a comparatively lower price than the incumbent. <br/> <br/>The third essay analyzes the price distribution of diesel in the Austrian retail gasoline market and tests predictions of the impact of the fraction of informed and uninformed consumers on the mean price and price variance. Further, introducing two measures of spatial competition, the relation of local competition between stations and the <br/>mean and variance are examined. In a pooled cross-section analysis a two step approach is followed. Initially, price levels are estimated with respect to the influence of competition, search costs, stations' location and further station-specific characteristics. Controlling for these observable price characteristics, the residuals are used in the second step to investigate the behavior of the price variance. In addition to OLS, to account for spatial spillover effects a Spatial Error Model (SEM) is applied to estimate the price function. Additionally, tests on model specification and robustness checks using different weighting <br/>matrices, search cost proxies and dispersion measures are carried out. The results reveal a negative (positive) correlation between the fraction of informed (uninformed) consumers and the mean price. Further, price variance shows an inverse U-shape with the fraction of informed consumers. Thus, the variance initially increases as the proportion of informed consumers increases and starts to decline <br/>after the share of informed exceeds a threshold of roughly 43%. These findings are in line with predictions of classical search models, most notably Stahl (1989), and <br/>empirically support the meaning of consumer search in the context of oligopolistic pricing. Further, the mean price decreases as competition intensifies whereas the Price <br/>variance increases under increased entry competition (Janssen & Moraga-Gonzalez (2004), Carlson & McAfee (1983)). This suggests stations' tendency to focus more <br/>strongly on the lower price segment as competition increases.
Original languageEnglish
Awarding Institution
  • WU Vienna
Publication statusPublished - 7 Sep 2018

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