Loughborough University. Department of Economics. Discussion Paper Series;WP 2008 - 03
The paper extends the Salop model of localized competition by allowing firms to have heterogeneous costs. We provide a general but highly tractable analytical solution for the equilibrium prices, and we study the long-run properties of the model using two different entry games. We show that cost heterogeneity affects the efficiency of the market equilibrium by increasing welfare and inducing less excessive entry. Further, we illustrate the positive effects of the existence of a selection mechanism, which induces less efficient firms not to start production. The model also replicates some recent results on dense markets.
This is a working paper. It is also available at: http://ideas.repec.org/p/lbo/lbowps/2008_03.html