Simple Markov-Perfect Industry Dynamics

48 Pages Posted: 18 Jul 2015

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

National University of Singapore (NUS) - NUS Business School

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2015

Abstract

This paper develops a tractable model for the computational and empirical analysis of infinite-horizon oligopoly dynamics. It features aggregate uncertainty, sunk entry costs, stochastic idiosyncratic technological progress, and irreversible exit. We develop a fast algorithm for computing a symmetric Markov-perfect equilibrium that finds the fixed points of a finite sequence of low-dimensional contraction mappings. If at most two heterogenous firms serve the industry, the result is the unique symmetric "natural'' equilibrium in which a firm with high flow profit never exits leaving behind a low flow profit competitor. We use this to demonstrate numerically that the welfare gains from directly correcting potential duopolists' suboptimal exercise of entry and exit options can dwarf those from indirectly doing so by changing the market's static competitive conduct. The hundreds of equilibrium calculations this requires take only a few minutes on an off-the-shelf laptop computer. When the market can support more than two firms, our algorithm always finds a natural equilibrium. We present a simple rule for checking ex post whether the calculated equilibrium is unique, and we also show that the algorithm is fast enough for empirical work by simulating the estimation of the model's parameters with indirect inference.

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 (March 1, 2015). Available at SSRN: https://ssrn.com/abstract=2631506 or http://dx.doi.org/10.2139/ssrn.2631506

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

University of Notre Dame ( email )

United States

Tilburg University ( email )

Tilburg, 5000 LE
Netherlands

Nan Yang (Contact Author)

National University of Singapore (NUS) - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

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