Simple Markov-Perfect Industry Dynamics

83 Pages Posted: 6 Dec 2010

See all articles by Jaap H. Abbring

Jaap H. Abbring

Tilburg University - Department of Econometrics & Operations Research; Tilburg University - Center for Economic Research (CentER); Tinbergen Institute; IZA Institute of Labor Economics

Jeffrey R. Campbell

University of Notre Dame; Tilburg University

Nan Yang

University of Amsterdam and Tinbergen Institute

Multiple version iconThere are 2 versions of this paper

Date Written: November 30, 2010

Abstract

This paper develops a tractable model for the computational and empirical analysis of infinite-horizon oligopoly dynamics. It features aggregate demand uncertainty, sunk entry costs, stochastic idiosyncratic technological progress, and irreversible exit. We develop an algorithm for computing a symmetric Markov-perfect equilibrium quickly by finding the fixed points to a finite sequence of low-dimensional contraction mappings. If at most two heterogenous firms serve the industry, the result is the unique "natural" equilibrium in which a high profitability firm never exits leaving behind a low profitability competitor. With more than two firms, the algorithm always finds a natural equilibrium. We present a simple rule for checking ex post whether the calculated equilibrium is unique, and we illustrate the model's application by assessing how price collusion impacts consumer and total surplus in a market for a new product that requires costly development. The results confirm Fershtman and Pakes' (2000) finding that collusive pricing can increase consumer surplus by stimulating product development. A distinguishing feature of our analysis is that we are able to assess the results' robustness across hundreds of parameter values in only a few minutes on an off-the-shelf laptop computer.

Keywords: Sunk Costs, Demand Uncertainty, Markov-Perfect Equilibrium, Learning-By-Doing, Technology Innovation

JEL Classification: L13

Suggested Citation

Abbring, Jaap H. and Campbell, Jeffrey R. and Yang, Nan, Simple Markov-Perfect Industry Dynamics (November 30, 2010). FRB of Chicago Working Paper No. 2010-21, Available at SSRN: https://ssrn.com/abstract=1721047 or http://dx.doi.org/10.2139/ssrn.1721047

Jaap H. Abbring

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands

HOME PAGE: http://center.uvt.nl/staff/abbring/

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

HOME PAGE: http://center.uvt.nl/staff/abbring/

Tinbergen Institute

Roetersstraat 31
Amsterdam, 1018WB
Netherlands

HOME PAGE: http://www.tinbergen.nl

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Jeffrey R. Campbell (Contact Author)

University of Notre Dame ( email )

United States

Tilburg University ( email )

Tilburg, 5000 LE
Netherlands

Nan Yang

University of Amsterdam and Tinbergen Institute ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

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