Price markups in oligopoly models with differentiated products

Abstract

I show that the relationship between the toughness of price competition and market size in oligopoly models depends on assumptions about the shape of preferences. In a Perloff and Salop model of nonlocalized taste for variety, price-cost margins remain bounded above zero as market size grows infinitely large, even as the number of firms grows without bound. By contrast, a Salop circle model of localized preferences generates price-cost margins that fall to zero as market size grows large. The toughness of price competition never reaches competitive levels if nonlocalized preferences generate entry opportunities that expand the set of product variants. The toughness of price competition rises to competitive levels if localized preferences generate entry opportunities to "fill in" product space. I also outline an empirical test for boundedness of price-cost margins by examining boundedness of firm revenues in chain and non-chain restaurants in Census of Retail Trade data.