We test for this declining price differential using data for producers located in Taiwan and China, which together accounted for 72% of the market in 2011. In practice, Chinese producers enter the market for a given semiconductor technology at least 2 years later than Taiwanese producers, so wetreat Taiwan as the "leader" and China as the "follower." We find that on average the price gap between Taiwan and China closes substantially over the life of a given semiconductor technology, falling from 39% in the year of Chinese entry to 10% after 5 years.
This setup yields two intuitive results. First, the switching cost generates equilibrium price dispersion. The idea here is that the switching cost partly insulates the leading firm from competition from the lower-price lagging supplier. This allows the leader to retain its past customers evenwhen charging a higher price than the lagging supplier. Second, the price difference between the leading and lagging supplier narrows over time for a particular process technology. When the lagging supplier enters, the leader has a large base of customers. It wishes to charge a relatively highprice to these buyers, who are partially locked-in because of the startup cost. However, as the leader's original customer base exits the market, the leader will have a stronger incentive to compete aggressively for newly entering customers. This reduces the price gap between the leader andfollower. This result is a simple but important property of the model, as it yields a testable prediction about the source of price dispersion that is not consistent with many forms of unobservable quality differences across suppliers. This gives us a way of distinguishing between competingexplanations for the observed price differences in Section 5.
solution market leader upper intermediate test key | temp
While this cross-sectional approach likely captures persistent differences in product quality across countries, our results highlight dynamic aspects of intermediate input markets that may confound quality inference based on market shares. In the model described in Section 4, differences in market share across suppliers do not necessarily reflect differences in product quality. Rather, the leading firm achieves a large market share simply by entering the market first and locking in a large number of customers early on. In the semiconductor foundrycontext, the average difference in Taiwanese and Chinese market shares would overstate the quality difference between the two.50 Moreover, the leader'srelative price and relative market share fall as its relative quality increases from period 2 to 3. In this case both price (unit value) and market share based approaches to inferring quality would suggest declining relative quality, when it was actually increasing. We conclude from this exercisethat even if long-run market share is a faithful indicator of average quality, the theoretical case for identifying the dynamics of product quality using changes in market share is not necessarily strong. Identifying these dynamics is critical to characterizing theeffects of entry by new offshore suppliers. We suspect that progress on this front will likely require a more explicit application of models with product market frictions. 2ff7e9595c
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