Re-examining the effects of switching costs

Consumers often incur costs when switching from one product to another. Recently, there has been renewed debate within the literature about whether these switching costs lead to higher prices. We build a theoretical model of dynamic competition and solve it analytically for a wide range of switching costs. We provide a simple condition which determines whether switching costs raise or lower long-run prices. We also show that even if switching costs reduce prices in the long run, they may still increase prices in the short run. Finally, switching costs redistribute surplus across time, and as such are shown to sometimes increase consumer welfare.

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