Dynamic Price Competition with Switching Costs

Abstract

We characterize a relatively simple Markov Perfect equilibrium in a continuous-time dynamic model of competition with switching costs. When firms cannot price-discriminate between old and new consumers, the effect of switching costs on prices critically depends on the degree of market share asymmetries: If firms’ market shares are sufficiently asymmetric, an increase in switching costs leads to higher prices. However, as market shares become sufficiently symmetric, price competition turns fiercer, and in the long-run, switching costs have a pro-competitive effect. If firms can price-discriminate, an increase in switching costs make all consumers better off regardless of market structure.