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“Telecommunications Service and Policy” Term Project #11
YoungKi KimYoungKi KimUnSil Kim
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C t tContentsIntroductiont oduct oNumerical ExampleThe Second PeriodThe Second PeriodThe First PeriodC l iConclusionReferencesAppendix
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I IntroductionI. IntroductionWhat is consumer switching costsat s co su e s tc g costs
The negative costs that a consumer incurs as a result of changing suppliers, brands or products.g g pp pSwitching costs act as apotential barrier
monetary psychological effort and time based
Artificial costs Uncertainty costs Learning costsTransaction costs Unfamiliarity costs Transaction costs
Searching costsTraining costs
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I IntroductionI. Introduction3 types of switching costs3 types o s tc g costs
transaction costslearning costslearning costsartificial(contractual) costs
exogenous switching costs Endogenous switching costsTransaction costsLearning costs
Artificial(contractual ) costsg
Exogenous : 외생의Endogenous: 내생의
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I IntroductionI. IntroductionTransaction costsa sact o costs
Reflect real social costs of switching between brandsCosts in switching between completely identical brandsCosts in switching between completely identical brandsExample
Changing checking accountsChanging checking accountsChanging rent company for some equipmentsChanging mobile supplier SKT <‐> KTF
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I IntroductionI. IntroductionLearning costsea g costs
Reflect real social costs of switching between brandsCosts in switching same product but other brands Costs in switching same product but other brands Example
Changing machine with compatible softwareChanging machine with compatible softwareChanging cake mix QUERTY keyboard VS Dvorak Keyboard
QUERTY keyboard Dvorak Keyboard
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I IntroductionI. IntroductionArtificial(contractual) costst c a (co t actua ) costs
Arises entirely at firm’s discretionCosts in switching same product but other brands Costs in switching same product but other brands Act like penalizing those who changing companiesExampleExample
Frequent‐flyer rewarding programsOffering trading stamps by some retailersg g p yDiscount coupons valid for the next purchase
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I IntroductionI. IntroductionTwo main pointsp
Switching Costs make firm's demand more inelastic Reduce rivalrySegment market into submarketseach submarket contains consumers who have previous bough from a firm and under monopolized effect by that firmbough from a firm and under monopolized effect by that firmEquilibrium may be the same as collusive solution with no switching costsI d fi ' li ti i l t i iti t d b Increased firm's monopolistic social costs is mitigated by increased consumer choiceDifferentiating identical product through switching cost yields no benefits
Costs in switching same product but other brands Costs in switching same product but other brands
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I I t d tiI. IntroductionTwo main pointso a po ts
Monopoly power leads to vigorous competitionSwitching costs do not make firms better offgFerocious competition to attract new customer may dissipate firms’ extra monopolistic returns and leave them worse off
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II Numerical ExampleII. Numerical Example
Demand: p = ‐q + 100MC = 10 (contant)
Monopoly(collusive oligopoly) Cournot Competition1 (100 10) 45255
q
p
= − =
=
60 / 2 30
100 (30 30) 4030 (40 10) 900
each firmq
pfit
= =
= − + =×55
55 45 10 45 2025pprofit = × − × =
30 (40 10) 900
900 2 1800each firm
total firm
profit
profit
= × − =
= × =10
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II Numerical ExampleII. Numerical ExampleWhat if Frequent‐flyer discount=10 is introduced?
Noncooperative quantity‐setting equilibrium22 5q =
q y
cos
22.5,
55 10 65
22.5 (65 10 10 ) 1012.5
each firm
each firm demand curve discount
each firm t discount
q
p
profit
=
= + =
= × − − =cos( )each firm t discountp f
Consumers do not benefit becauseConsumers do not benefit becausethe price simply end up with (collusive price + discounts)
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III. The Second PeriodNoncooperative Behavior looks collusive
( )
:r
A
P f q
fraction of market by firm Aσ
≥
1
(1 ) :( ) ( )
( ) ( )
B A
A A
fraction of market by firm Bf p h p q
f f h
σ σ−
= −
= ≥( ) : ' ( cos )
( )( ) , ( ) 0
propotionof a firm s consumers switching tω ωωγ ω γ ωω
Γ ≥∂Γ
= ≥∂
Second period : mature market after consumers’ switching costs have been built up
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III. The Second PeriodNon‐cooperative Behavior looks collusive
( ) ( ) ( ) ( )[ ( )]Bp
A A A B B A B B Aq h p p p h p p dh rσ σ σ γ= + Γ + Γ∫( ) ( ) ( ) ( )[ ( )]Ap
q h p p p h p p dh rγ
σ σ σ γ=
= + Γ − + Γ − −∫A ll it it ith ti i AA sells it its own consumers with reservation prices >= AP
A sells B’s consumers with reservation prices >= and switching costs <= BP ( )B Ap p−
A sells B’s consumers with reservation prices in the range (PA ,PB) andreservation price less switching cost greater than or equal to PA
(1 ( )) ( ) ( ) ( ) ( )B B B A B B B B B A Bq p p h p h p p p h pσ σ σ= −Γ − = − Γ −
B ll it it ith ti i BB sells it its own consumers with reservation prices >= BP
B will sell consumers whose switching costs is greater than ( )B Ap p−13
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III. The Second PeriodNon‐cooperative Behavior looks collusive
Firm A’s first order conditions st o de co d t o
A A A⎡ ⎤∂ ∂ ∂
' , 'A AA s profit c A s total costπ = =
0A A A
A AA A A
c qq pp q pπ ⎡ ⎤∂ ∂ ∂
= + − =⎢ ⎥∂ ∂ ∂⎣ ⎦
( ) ( ) ( ) ( )[ ( )]B
A
pA A A B B A B B A
p
q h p p p h p p dh rγ
σ σ σ γ=
= + Γ − + Γ − −∫
0 ( ) ( ) ( ) ( )[ ( )]B
A
pA A B B A B B A
p
h p p p h p p dh rγ
σ σ σ γ=
= + Γ − + Γ − − +∫
( ) ( ) ( ) ( )[ ( )]B
A
pAA A A B B A B B A
Ap
cp h p p p h p p dh rq γ
σ σ γ σ γ γ=
⎡ ⎤⎡ ⎤∂ ′− − Γ − + − Γ − −⎢ ⎥⎢ ⎥∂ ⎢ ⎥⎣ ⎦ ⎣ ⎦∫
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III. The Second PeriodNon‐cooperative Behavior looks collusive
At a symmetric equilibriumt a sy et c equ b u
A⎡ ⎤⎛ ⎞
12,A B A Bp p p σ σ= = = =
1 ( ) ( ( ) (0) ( )) 02
A
A
ch p p h p h pq
γ⎡ ⎤⎛ ⎞∂ ′+ − − =⎢ ⎥⎜ ⎟∂⎝ ⎠⎣ ⎦
(0) 0 ,
1
If then wecan rewrite
q q
γ
′ ′
− >
⎛ ⎞⎛ ⎞⎛ ⎞ ⎛ ⎞ Monopoly price 1( ) ( ) 02 2 2
A Bq qh p p c c h p′ ′⎛ ⎞⎛ ⎞⎛ ⎞ ⎛ ⎞ ′+ − ∂ + ∂ =⎜ ⎟⎜ ⎟ ⎜ ⎟⎜ ⎟⎝ ⎠ ⎝ ⎠⎝ ⎠⎝ ⎠
p y pwithout switching costs
, (0)A
ontheother hand imlies that
c
γ →∞
⎛ ⎞∂Competitive price without switching costs
( 0 ' 'A
cp p unit cost of Aq
⎛ ⎞∂− = → =⎜ ⎟∂⎝ ⎠
g
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IV. The first periodpCompetition for market share
Firms will compete more aggressively in the first s co pete o e agg ess ve y t e stperiod with switching costs in the second period
First First Secondperiod
Increased l
period
Increased k h
period
Increased fisales market share profits
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IV. The first periodpCompetition for market share
1 1 1 1 1( , ) ( ( , ))A A A B A A Bv v v vπ π λ σ≡ +First period strategic variable of firm A
First period strategic variable of firm B, which is given
Fi i d fi f fi A
1Av
1BvA First period profits of firm A
Second period profits of firm B
First period market share of firm A
1Aπ
2AπAδ First period market share of firm A
Discount factor in first period
δ
λ
:Aq I n q u a n t i t y c o m p e t i t i o n⎧⎪ 11
1
1
:
1 / :A
A
A
q I n q u a n t i t y c o m p e t i t i o nv
p In p r i c e c o m p e t i t i o n
T h e m o r e v m e a n s th e f i r m w i l l p la y m o r e a g g r e s s i v e l y
⎧⎪= ⎨⎪⎩
10A
Avs o th a t σ∂
∂>
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IV. The first periodpCompetition for market share
In non‐cooperative equilibrium
1 1 1 2 1 1( , ) ( ( , ))A A A B A A A Bv v v vπ π λπ σ≡ +A A AA ∂ ∂ ∂∂
In non cooperative equilibrium
1 1
1 1 1
0A A AA
A A A A
A A
v v vπ π σπ λ
σ∂ ∂ ∂∂
= + =∂ ∂ ∂ ∂
2 1
1
, 0A A
A AIfv
π πσ
∂ ∂<
∂ ∂Higher market share in the first period makes the firm better off in second periodFirm A and B choose to gain more market share and this lead to ( )*
1 1A Av v>
more aggressive competition in first period.Example: Bank gives money, book‐tickets, free banking services
to college students to make them open accounts in first period
( )
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IV. The first periodpCompetition for market shareSwitching costs reduce social welfareS tc g costs educe soc a e a e
Switching cost =0 : industry output will be socially optimalSwitching cost >0 : industry produce excessive output (1st) Switching cost >0 : industry produce excessive output (1 )
industry produce too little output (2nd)
1noSCw 1
with SCwFirst Period
1 2 1 2noSC noSC with SC with SCw w w w+ > +
2noSCw 2
with SCwSecondPeriod
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V C l iV. ConclusionSwitching costs can lead to monopoly profitsS tc g costs ca ead to o opo y p o tsThese profits induce greater competition in the first periodperiodSwitching costs generally reduce social welfareSo regulatory policies that lower switching costs are So, regulatory policies that lower switching costs are needed
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VI R fVI. References[1] George J. Stigler, ”A Theory of Oligopoly”,1964[2] Mike Hess, “MANAGING CUSTOMER SWITCHING COSTS”, 2002[3] Tracy R. Lewis,Managing “Switching Costs in MultiperiodProcurements with Strategic Buyers” 2003Procurements with Strategic Buyers , 2003[4] Edward J. Green, ”Noncooperative Collusion under Imperfect Price Information”,1984[5] Ciara McSorley, ”Switching Costs”, 2003[6] Jean‐Pierre Dube, “Do switching costs make markets less competitive?” 2006competitive? , 2006[7] 이영환, ”미시경제학”, 1997[8] http://en.wikipedia.org/wiki/Cournot_competition[ ] p p g _ p[9] http://en.wikipedia.org/wiki/Switching_barriers
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A di IAppendix ICournot competitionCournot competitionCournot competition is an economic model used to describe industry structure. It so called after Antoine Augustin Cournot (1801‐1877) after he observed competition in a spring water duopoly. It has the following features:
There is more than one firm and all firms produce a homogeneous product; Firms do not cooperate; Firms have market power; The number of firms is fixed; Firms compete in quantities, and choose quantities simultaneously; There is strategic behaviour by the firms.
An essential assumption of this model is that each firm aims to maximize profits, based on the expectation that its own output decision will not have an effect on the decisions of its rivals. Price is a commonly known decreasing function of total output. All firms know N, the total number of firms in the market, and take the output of the oth h f h f ( ) ll h f d k l dhers as given. Each firm has a cost function ci(qi). Normally the cost functions are treated as common knowledge. The cost functions may be the same or different among firms. The market price is set at a level such that demand equals the total quantity produced by both firms. Each firm takes the quantity set by its competitors as a given, evaluates its residual demand, and then behaves as a monopoly.
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Appendix IIAppendix II
Best Cournot response derivation
( )100 ( ) 10AA B A Aq q q qπ = − + −( )100 ( ) 10A B A Aq q q qπ +
Aπ∂ ( )100 ( ) 10A A BA
q q qqπ∂
=− + − + −∂
( )100 ( ) 10 0A
A A BA
q q qqπ∂
=− + − + − =∂
90 90,2 2
A
B AA B
qq qq q− −
= =
30, 30A Bq q= =23