Research Archive

Working Paper, January 2009

Publication type: Working paper

Research Archive Topic: Business Economics and Public Policy, Marketing, Media and Technology, Strategy

Abstract

We propose and estimate a model of dynamic oligopoly with durable goods and endogenous innovation. Firms make dynamic pricing and investment decisions while taking into account the dynamic behavior of consumers who anticipate the product improvements and price declines. The distribution of currently owned products is a state variable that affects current demand and evolves endogenously as consumers make replacement purchases. Our work extends the dynamic oligopoly framework of Ericson and Pakes (1995) to incorporate durable goods. We propose an alternative approach to bounding the state space that is less restrictive of frontier firms and yields an endogenous long-run rate of innovation.

We estimate the model for the PC microprocessor industry and perform counterfactuals to measure the benefits of competition. Consumer surplus is 2.5 percent higher ($5 billion per year) with AMD than if Intel were a monopolist. Innovation, however, would be higher without AMD present. Counterfactuals reveal that consumer surplus can actually increase as the market moves toward monopoly, which suggests that policymakers ought to consider the dynamic trade-off of lower current consumer surplus from higher prices for higher future surplus from more innovation. Comparative statics reveal that competition does induce higher innovation if consumers have sufficiently high preferences for quality and low price sensitivity.

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