The Effect of a Credit Crunch on Equilibrium Market Structure

Martin Watzinger

Computational Economics, 2016, vol. 48, issue 1, No 5, 105-130

Abstract: Abstract This article examines the impact of a credit crunch on market structure. We construct and simulate a dynamic model of a duopolistic industry in which firms’ investments in capacity are constrained by the availability of credit. In such an industry, the dynamic interaction of credit limits and the competitive responses of firms turn out to be a powerful transmission mechanism by which the effects of shocks persist and are amplified. We show that a small, temporary shock to one firm’s capacity can lead to its market exit, even if it is equally productive as the remaining incumbent. Consequently, if a recession is accompanied by a credit crunch, its cleansing effect might lead to monopolization of markets and welfare losses.

Keywords: Dynamic oligopoly; Endogenous financial structure; Credit rationing; Ericson–Pakes framework; Experience based Markov equilibrium (search for similar items in EconPapers)
JEL-codes: C73 G32 L13 (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1007/s10614-015-9508-5

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