Consumer Inertia and Market Power

Abstract

We study the pricing decision of firms in the presence of consumer inertia. Inertia, which can arise from habit formation, brand loyalty, and switching costs, generates dynamic pricing incentives. These incentives mediate the impact of competition on market power. For example, dynamic incentives can limit the equilibrium price effects of a horizontal merger. We develop an empirical model to estimate consumer inertia and dynamic pricing incentives using market-level data. We apply the model to a hypothetical merger of retail gasoline companies, and we find that a static model predicts greater price increases than those obtained while accounting for dynamics.