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Salop Circle
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Outline
Salop Circle
Section Outline
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Outline
Salop Circle
v t 2 p
Two Stage Game (how is this different from class?)
Stage 1: Two firms enter, simultaneously locate at a and b.
Stage 2: Both firms simultaneously choose prices pa and pb
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Outline
Salop Circle
Indifference condition:
v (x a)2 p1 = v (1 b x )2 p2
Solve for threshold x at which consumer is indifferent
x=
1+ab
p2 p1
+
2
2 (1 a b )
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Outline
Salop Circle
Indifference condition:
v (x a)2 p1 = v (1 b x )2 p2
x 2 + a2 2xa + p1 = x 2 + (1 b )2 2x (1 b ) + p2
2x (1 a b ) = (1 b )2 a2 + p2 p1
p2 p1
(1 b )2 a2
Threshold x =
+
2 (1 a b )
2 (1 a b )
p2 p1
(1 a b ) (1 + a b )
=
+
2 (1 a b )
2 (1 a b )
1+ab
p2 p1
=
+
2
2 (1 a b )
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Outline
Salop Circle
1ab
p2 p1
+
2
2 (1 a b )
p1 p2
1ab
+
D 2 ( p1 , p2 ) = 1 x = b +
2
2 (1 a b )
D 1 ( p1 , p2 ) = x = a +
D1 (p1 , p2 ) = x =
a
+
|{z}
Everything
to left
1a b
2
| {z }
p2 p1
2 (1 a b )
|
{z
}
Outline
Salop Circle
1ab
p2 p1
1
a+
+
(p1 c )
=0
2
2 (1 a b )
2 (1 a b )
(1 a b )2 p2 + c
+
(p2 ; a, b ) = a (1 a b ) +
2
2
By symmetry,
P1
P2 (p1 ; a, b ) = b (1 a b ) +
(1 a b )2 p1 + c
+
2
2
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Outline
Salop Circle
p1
p2
ab
= c + (1 a b ) 1 +
3
ba
= c + (1 a b ) 1 +
3
Comparative statics
1. Less price competition when products are less substitutable
p1
ab
= (1 a b ) 1 +
>0
3
2. For given location a, movement of firm 2 towards the center
will decrease the price charged by firm 1.
p1
= 1 + a3 b 1a3b = 43 + 2b
<0
3
b
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Outline
Salop Circle
d 1
D1
1
= D1 dp
+
p
(
)
1
da
a +
da
D1 dp1
p1 da
D2 dp2
p2 da
=0
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Outline
Salop Circle
1
Recall in stage 2, firm 1 maximizes wrt price, so
p1 = 0
By the envelope theorem,
d 1
1
= (p1 c ) D
a +
da
D2 dp2
p2 da
h
1
+ dp
D1 + (p1 c )
da
|
{z
= p 1
1
D1
p1
i
}
which is 0
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Outline
Salop Circle
d 1
D1
D2 dp2
)
= (p1 c ) (
+
da
a
p da
|{z}
| 2{z }
Demand
effect
Strategic
effect
1
2
p2 p1
2 (1a b )2
35ab
6(1a b )
>0
= 3(12a+ab ) < 0
3
3
p2 da
2 (1a b )
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Outline
Salop Circle
d 1
<0
da
What is the intuition? Does more demand more profit?
What is the difference between holding prices fixed, and
12 / 19
Outline
Salop Circle
a=b=0
Social planner minimizes average transport cost.
a=b=
1
4
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Outline
Salop Circle
Outline
Salop Circle
15 / 19
Outline
Salop Circle
0, n1 from firm i is
indifferent between firm i and closest neighbor if
1
pi + tx = p + t
x
n
Outline
Salop Circle
Di (pi , p ) = 2x =
p + t/n pi
t
p + t/n pi
max (pi c )
f
p
t
i
t
n
Outline
Salop Circle
t 1
f
n n
Thus number of firms when profits are zero (with free entry)
n=
t/f
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Outline
Salop Circle
min nf + t 2n
n
Z 1/2n
xdx
Integrating, we get
min (nf + t/4n )
n
1
2 n.
equilibrium. Intuition?
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