Hotelling was right with decreasing returns to scale and a coalition-proof refinement

Chia-Hung Sun () and Fu-Chuan Lai

The Annals of Regional Science, 2013, vol. 50, issue 3, 953-971

Abstract: This paper provides a simple, realistic, and very slightly modified version of the production technology in Hotelling’s (Econ J 39:41–57, 1929 ) spatial model with linear transportation costs to overcome the nonexistence problem of equilibrium—decreasing returns to scale. It is shown that a pure strategy Nash equilibrium in price competition always exists for all location pairs and guarantees uniqueness if we utilize a coalition-proof refinement introduced by Bernheim et al. (J Econ Theory 42:1–12, 1987 ). Decreasing returns to scale reduce the profit a firm can capture through price undercutting and stabilize the price equilibrium due to the increasing average production cost of firms. As a consequence, duopoly firms agglomerating at the center of a line are shown to be at the unique location equilibrium. This paper confers a new validity to the so-called principle of minimum differentiation, in some sense, with the least deviation from the original Hotelling (Econ J 39:41–57, 1929 ) model. Copyright Springer-Verlag 2013

Keywords: D21; L13; R10 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1007/s00168-012-0528-y

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