Hotelling’s webshop

What is it about?

This paper adds a webshop to Hotelling's famous model of spatial competition. Just as Hotelling's model is a metaphor for product differentiation, the webshop is a metaphor for a so-called outside good; a good with different characteristics that might serve as an alternative option. In the context of Hotelling's model, thius is also konw as the reservation price: if the price plus transport costs of the goods in the model exceed the price of the outside good (or reservation price), consumers will buy the outside good. The main contribution of this paper is that the reservation price is now endogenous; it is modelled as a firm setting a price in response to to the other prices in the model. The analysis finds that prices for goods positively depend on transport costs, which would not be the case for an exogenous reservation price. If the webshop serves an alternative market as well, the price of that market is partly imported into the local market.

Featured Image

Why is it important?

Several versions of Hotelling's model are available. The ones with a reservation price have the common feature that the level of the reservation price completely determines the outcomes. The level is chosen arbitrarily however and is not affected by the firms in the model. This seems to be unrealistic. The model in this paper fixes this problem.