Price Competition in Markets with Customer Testing: The Captive Customer Effect

Heidrun Hoppe-Wewetzer and Ulrich Lehmann-Grube

No 6229, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We introduce product differentiation into the analysis of price competition in markets where suppliers test customers in order to assess whether they will pay for received goods or services. We find that, if the degree of differentiation is sufficiently high, suppliers may improve the average probability that their clientele will pay by charging higher prices. This helps suppliers to sustain high prices in equilibrium. Moreover, endogenizing locations in product space, we demonstrate that the high price level can be implemented in a pure-strategy subgame-perfect equilibrium with a high degree of differentiation. This is in contrast to the original Hotelling model with linear travel costs where a pure-strategy subgame-perfect equilibrium fails to exist.

Keywords: Hotelling; Iterated elimination of strictly dominated strategies; Mixed strategy; Price competition; Testing (search for similar items in EconPapers)
JEL-codes: D83 G21 L13 (search for similar items in EconPapers)
Date: 2007-04
New Economics Papers: this item is included in nep-com, nep-cse, nep-ind, nep-mic and nep-mkt
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Journal Article: Price competition in markets with customer testing: the captive customer effect (2008)
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