Price patterns in an oligopoly with switching cost and uncertain demand

Abstract

We investigate the characteristics of price patterns in an oligopoly market with costs for switching a provider. We consider two regimes of a company’s access to information. In the benchmark scenario, firms make decisions based on perfect information about demand. In the second – more realistic scenario – they conduct market research to estimate an unknown demand curve and therefore face uncertainty regarding their profit function, which in turn leads to sub-optimal decision making. We inspect how (1) a company’s access to information on demand, (2) costs for switching a provider and (3) the rate of market renewal, influence price patterns on the market. We show that a positive switching cost is a sufficient condition for price dispersion, as well as imperfect information about the company's profit function, e.g. from market research. We conclude that (1) the average price under the perfect information regime is lower than under market research based price setting, (2) a higher switching cost makes it easier for companies to coordinate their prices and (3) a higher rate of market renewal softens the influence of the switching cost on market price.