Geography Reference
In-Depth Information
competing in the same product and geographical space leads to a lower
overall elasticity of demand. Salop himself acknowledged that this obser-
vation is surprising (Salop 1979), although this interaction between the
consumer surplus, the brand characteristics and the price mean that such
competition only operates at lower price levels. At a very high monopoly
price level,
p
M
, the individual firm still has a monopoly position, mani-
fested in terms of elastic demand.
This major insight from the Salop model, namely that more competition
implies a smaller demand effect of a unilateral price rise, also provides us
with another fundamental insight into the nature of location behaviour. In
particular, it encourages firms to both differentiate their various products
and also to cluster their sales activities.
In order to see this we can reconsider the earlier insights of the Hotelling
model. The general conclusion of the Hotelling model is that if firms
are physically located together in geographical space, then the Bertrand
problem can only be avoided if firms ensure that non-price competition
operates. The problem with this is that the situation is often on a knife-
edge if the competing products are still basically very close substitutes
for each other, even if lots of branding and marketing is taking place in
order to persuade consumers otherwise. Consequently, there is always the
danger that consumers eventually come to realize the competing products
are indeed very close substitutes for each other, such that the whole local
equilibrium once again becomes unstable and subject to the Bertrand
problem. This implies that a stable outcome is only really possible if the
products are fundamentally different, in which case the firms may not
actually be competing for the same consumers.
In contrast, the Salop model implies that a high degree of product
differentiation acts as partial 'defence' against the Bertrand problem of
instability, and encourages firms to both differentiate their products and
cluster their sales outlets. In order to see this we recall that the distance in
product space between each brand variety is equal to
L/n
, where
L
is the
length of the Salop circle and
n
is the number of competing brands. As
such, having closer substitutes implies that the number of competing firms
n
is larger, and the product space distance between the firms
L/n
is smaller.
Under these conditions consumers have more possibilities to switch con-
sumption between adjacent brands if the prices of particular brands rise,
and in terms of Figure 3.21 this also implies that the monopoly price
p
M
rises. From the perspective of consumers, this implies that consumers have
a high degree of 'protection' from a price rise by a particular individual
producer, because the possibilities for switching producers are greater. At
the same time, for a given number
n
of brand alternatives, a larger market
choice space, defined as
L
, also implies that there is a greater characteris-
