Academic journal article Atlantic Economic Journal

Market Power and Output Stability under Demand Uncertainty

Academic journal article Atlantic Economic Journal

Market Power and Output Stability under Demand Uncertainty

Article excerpt

Market Power and Output Stability under Demand Uncertainty

It has been shown by Shaffer [Economics Letters, 1983] that market power has a destabilizing effect on output adjustments under multiplicative shocks to demand such that the market shares of large firms tend to behave in a pro-cyclical fashion. Quite contrary to Shaffer's findings, this note proves that market power tends instead to have a stabilizing impact on output stability, confirming the traditional industrial organization throughts.

Consider an industry facing random shocks to market demand. The output of the ith firm is [x.sub.i] and the total industry output is X = [ZIGMA][x.sub.i.] The stochastic market demand is defined as p = [alpha]p(X), where [alpha] is a positive random variable (with mean value of alpha) reflecting a multiplicatively stochastic shock to market demand, and P' (X) [is less than] O. The total cost function of the ith firm is c=c([x.sub.i]), where c' [is greater than] O and c" [is greater than] O.

The expected profit-maximizing output of the ith firm (denoted as [x.sub.i.sup.*]) then must satisfy the necessary condition: alpha p(X) (1 + [t.sub.i]/[eta] = c' ([x.sub.i.sup.*]), where [eta][=(dX/dp)(p/X)[is less than] O] is the price elasticity of demand and [t.sub.i][= (dX/d[x.sub.i.sup.*]) ([x.sub.i.sup.*]/X) [is greater than] 0] is the conjectural variation elasticity of the ith firm. Note that (1 (Mathematical Expression Omitted) Next, assume as in Shaffer that [eta] and [t. …

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