Discussion Paper Details

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Title: Why Do Market Shares Matter?: An Information-Based Theory

Author(s): Ramon Caminal and Xavier Vives

Publication Date: October 1992

Keyword(s): Consumer Learning, Herd Behaviour, Market Share, Oligopoly, Quality Signals and Signal-jamming

Programme Area(s): Applied Macroeconomics

Abstract: We analyse the informational content of market shares and prices in a dynamic duopoly model in which consumers have heterogenous information on the quality differential (q) of two goods. It is shown that when firms are poorly informed about q, and therefore the ability of prices to reveal information is limited, consumers rationally believe that a firm with a high market share is likely to produce a high-quality good. As a result, firms try to signal-jam the inferences of consumers and compete for market shares beyond the level explained by short-run profit maximization. The consequence is that the market is more competitive in the first stages of the game and approaches the benchmark one-shot full information equilibrium prices as consumers and firms learn about q. Further, it is found that consumers display herd behaviour with the consequence that they learn q slowly, slowing down, in turn, the rate of convergence of prices to their benchmark levels. When firms are informed about q, and prices have the potential to signal quality, multiple equilibria may exist, but there is always one equilibrium in which market shares are a positive signal of quality.

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Bibliographic Reference

Caminal, R and Vives, X. 1992. 'Why Do Market Shares Matter?: An Information-Based Theory'. London, Centre for Economic Policy Research.