Essays on non-price strategies in firm competition

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Date

2006-05

Authors

Lee, Seokhoon, 1971-

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Abstract

This dissertation studies on firm competition in two industries, airline industry and banking industry. Firms compete not only in price but also in non-price strategies. The first essay examines cost structure decision of airlines as a non-price strategy theoretically, and the second essay examines branching decision of banks as a non-price strategy using Korean banking data empirically. The first essay examines the equilibria of a duopoly game modelling airline competition. Two ex ante identical firms choose a cost structure in the fist stage and then compete in price. I assume that airlines with undifferentiated service (i.e., only having one “economy class”) have lower costs, while airlines differentiating their products have higher costs. There are three types of subgame perfect equilibria (SPE): symmetric higher-cost SPE, symmetric lower-cost SPE, and asymmetric SPE. Without cost advantages, entry of an airline with undifferentiated service is not profitable. Examples illustrate the market conditions that induce the asymmetric equilibrium in which the two ex ante identical airlines choose different cost structures. I show that in asymmetric equilibria, an airline running a low-cost airplane may have higher profits than an airline running a normal airplane, except when tourists are not price sensitive and the social benefit of business class service is high. Although both the subgame perfect equilibria and the equilibria maximizing social welfare are affected critically by the cost advantage and social benefit of business class service, they differ for some parameter ranges. Not only symmetric equilibria but also asymmetric equilibria may maximize social welfare for some parameters. The second essay examines the effect of competition between Korean commercial banks with widely divergent branch network structures in the period between 1994 to 1996. It develops a discrete choice model in a competitive framework and allows for banks to choose their deposit interest rate and branch network as well as for depositors to choose a bank for deposit services. The estimates show that branching competition did not change a bank’s market power. They also show that regional banks with locally intensive branch networks had much higher markups than did the nationwide banks. The results indicate that overlap between different banks’ branch networks increases competition between them and that nationwide banks have a higher cross price elasticity of demand than regional banks. The results show that banks located their branches more in markets with higher branch elasticities

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