Competing markets

Abstract

In a model of two-dimensional spatial competition the notion of competition between market places is analyzed. While one dimension can be interpreted as geographical distance the other dimension is some product characteristic (like maturity of a futures contract). Initially single product firms select a specific location and variety and later, at a second stage, they compete in prices. In the present framework agglomeration economies arise endogenously due to savings in transportation costs for consumers. For many parameter constellations I demonstrate that entrants might prefer to settle in existing markets rather than setting up their business somewhere in between. In particular, the emergence of new market places is less likely as transportation costs decline. Despite the strong forces towards agglomeration, multiple markets will arise under free entry of firms when markets are large enough. Furthermore, pure strategy equilibria in location do exist when search costs are sufficiently important even for linear transportation costs. The agglomeration economies provide organizers of market places with some degree of market power. Indirect competition between fiscal authorities is analyzed when jurisdictions impose transactions taxes. Equilibrium tax rates depend positively on transportation costs. Hence the deregulation wave in financial markets may be understood as an equilibrium reaction to a significant decline in transportation costs. The model features strong incentives for the harmonization of regulation.