Demand Uncertainty, Market Structure, and Competition in Availability

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This research will study the effects of aggregate demand uncertainty on retail and consumer service markets when prices do not necessarily clear markets. Inflexible prices imply potential stockouts so, when there are costs of shopping, consumers will choose where to shop based on both price and availability (the probability of finding the good in stock). While availability is often ignored in economics models, it is a genuine concern for consumers and firms in a wide variety of retail and consumer service industries. For example, companies who regularly advertise availability are car dealers, video rental chains, mail order suppliers, department stores, and appliance stores. The work will initially focus on answering two questions that arise in models of availability (or service rate) competition. The first question is how market structure, prices, and availability are determined when firms compete in availability but their capacity or inventory (and therefore availability) is unobservable to consumers. This research will answer this question by extending existing models of competition when availability is observable to consider oligopoly inventory choice with asymmetric information. Using a game theoretic model, the work will ask how prices and availability are determined when consumers use price as a signal of availability. In a variety of static models (corresponding to Bertrand and Cournot timings) the work will show that firms charge high prices and earn supra-competitive profits (even in the limit as the market structure becomes arbitrarily competitive). Dynamic extensions in which consumers learn over time and firms acquire reputations for high availability are proposed. The second question is how manufacturer-retailer contracts, specifically royalty or revenue sharing contracts, can correct distortions created by demand uncertainty, vertical separation, and downstream competition. A young literature in economics has begun to show how vertical restraints can increase welfare and profits by increasing inventory holdings when the manufacturer is a monopolist, demand is uncertain, and retailers compete (and also by decreasing destructive competition in models with flexible prices). This work will examine models of royalty or revenue sharing contracts, which have recently become widely used in the video rental industry (and others), and argue that revenue sharing is more efficient and versatile than other vertical restraints.