The generalized circular model

Abstract

In this paper we present a generalization of the circular model. In this model there are two concentric circular markets, which enables us to study two types of markets simultaneously. There are switching costs involved for moving from one circle to the other circle, which can also be thought of as transformation costs. Consumers have valuations for the product of the firms, depending on the circle they live on. Equilibrium prices then of course are affected by both switching costs and consumers' valuations. An interesting insight that comes from this approach is that an extension of the circular model may invalidate the familiar principle that free entry is characterized by too many firms. Furthermore we discuss the effect of introducing reservation prices on the equilibrium outcome using a constructive approach