The Circular City with Heterogeneous Firms

Abstract

The paper extends the Salop model of localized competition by allowing rms to have heterogeneous costs. We provide a general but highly tractable analytical solution for the equilibrium prices, and we study the long-run properties of the model using two dierent entry games. We show that cost heterogeneity aects the eciency of the market equilibrium by increasing welfare and inducing less excessive entry. Further, we illustrate the positive eects of the existence of a selection mechanism, which induces less ecient rms not to start production. The model also replicates some recent results on dense markets.