DP8970 Switching Costs and Equilibrium Prices

Author(s): Luís M B Cabral
Publication Date: May 2012
Keyword(s): price competition, switching costs
JEL(s): l13
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8970

In a competitive environment, switching costs have two effects. First, they increase the market power of a seller with locked-in customers. Second, they increase competition for new customers. I provide conditions under which switching costs decrease or increase equilibrium prices. Taken together, the suggest that, if markets are very competitive to begin with, then switching costs make them even more competitive; whereas if markets are not very competitive to begin with, then switching costs make them even less competitive. In the above statements, by "competitive" I mean a market that is close to a symmetric duopoly or one where the sellers' discount factor is very high.