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A Dynamic Quality Ladder Model with Entry and Exit: Exploring the Equilibrium Correspondence Using the Homotopy Method

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journal contribution
posted on 01.03.2009, 00:00 by Ron N. Borkovsky, Ulrich Doraszelski, Yaroslav Kryukov
This paper explores the equilibrium correspondence of a dynamic quality ladder model with entry and exit using the homotopy method. The homotopy method facilitates exploring the equilibrium correspondence in a systematic fashion; it is ideally suited for investigating the economic phenomena that arise as one moves through the parameter space and is especially useful in games that have multiple equilibria. We discuss the theory of the homotopy method and its application to dynamic stochastic games. We then present the following results: First, we find that a change in parameterization that increases (decreases) the cost (benefit) of achieving or maintaining any given product quality yields more asymmetric industry structures. Second, we show that the possibility of entry and exit alone gives rise to predatory and limit investment. Third, we illustrate and discuss the multiple equilibria that arise in the quality ladder model, highlighting the presence of entry and exit as a source of multiplicity.