Say there's a bunch of competing businesses, car repair shops for example, in a certain market. Business is good and there's a substantial average turnaround time for all of them. Someone decides they're going to add a bunch of capacity - hire more mechanics and expand their space.

Say that shop finds as soon as they add the capacity, customers figure it out, get in the shortest line available to them, and very quickly the capacity is all in use, and the turnaround time is only lower, slightly, as a result of the total supply in the entire market being greater. The shop's business volume has quickly increased in close proportion to the expansion, but that's about all that changed. What is the best term for what this observation says about the market? Low perceived switching costs? High market fluidity?

Say the opposite turns out to be true. The shop adds the same extra capacity, but the total number of people walking in the door doesn't change, or is sluggish to change. Turnaround time goes down, business volume stays the same, profits go down due to the unused capacity, and the competitors are humming along as though nothing happened. The managers are left thinking, "Either we have a reputation or marketing problem, or the market we're in is just ____." What's the term for a market that behaves this way?


If you want a general term, I would suggest frictionless market.

Normally, we would expect customers to reallocate themselves until the waiting time across shops is equalised. Indeed, all else equal, if the waiting time at $A$ is greater than that at $B$ then customers will switch from $A$ to $B$ until the discrepancy is eliminated.

If we do not observe such switching occurring then we say there is some sort of "market friction". Some examples of frictions:

  • switching costs: switching to a new supplier is costly and the gain in reduced waiting time is not sufficient to compensate consumers for the cost of switching;
  • informational friction: some consumers don't know of the existence of firm $B$ (or don't know how long its waiting time is). Perhaps they could acquire the missing information, but doing so takes time and effort, which is costly.
  • principal-agent problems: customers might rationally trust their current supplier because of positive past experiences (formally, reputation can solve moral hazard problems). Or perhaps they just had enough time to learn whether their current supplier is competent or not; something they don't know about the alternatives.
  • product differentiation: perhaps people like some products more than others. $B$ might be further from their house than $A$ so that visiting $B$ takes longer. Or maybe they know the mechanic at $A$ and like to talk to him/her. This makes them reluctant to switch to $B$.
  • behavioural factors: if consumers do/can not act rationally then they may fail to take advantage of potential gains from switching.

Here's a neat quote on the issue:

As recognised by the 2010 Nobel prize, the study of market frictions has generated rich insights in many areas of economics, especially macroeconomics, labour economics and monetary theory.1 In industrial organisation, analysis has focussed on understanding how market frictions can create a source of market power by restricting consumers' ability to change suppliers (Wilson, 2012).


The basic thing that this scenario says is that capacity/supply was below demand, in the sense that the customers would want to be serviced earlier than they did.

And whatever the switching costs, by revealed preference it appears these costs were lower than the monetary value of extra utility gained by consumers because now they are serviced earlier.

So no, we cannot say that switching costs are low, only that they are lower than the value to be serviced earlier.


Perhaps it would make sense when trying to figure out how to label a particular instance in the functioning of the specific market you have in mind, to start from a typical market set-up and then try to work out what could the specific configuration mean in the context of that market.

As an example consider the case of the auto repair shops referenced in the question; I assume that the reference is not about specialized shops or those certified to deal with a single car brand; fixing the relevant market withing a given spatial territory eg 'the auto repair shops located downtown' could probably be used as a particular instance of a market operating under monopolistic competition; there are 'many firms' that supply a slightly differentiated product and 'entry' and 'exit' is relatively easy.

Now, in the context of a market under monopolistic competition, there is spare capacity usually maintained to defer competition; it could be the case that the shops in the example expand capacity utilization in order to lower prices, soak up demand and run new entrants out of business. For incumbent firms, this could mean an increase in their turnover with or without impact on profits (that depends upon the particulars of the model) whereas for the new entrants it could very well mean that their customer base wears thin (because of consumers' 'brand loyalty' eg they trust their tried-and-tested mechanics, or because of simple cost calculations eg the new shops are located 'far away' presumably because the old shops have already been located at 'proper' locations 'downtown') and they are effectively ejected from the marker altogether.

So, in this context, the managers should realize the monopolistic structure of the market and either advertise more or try to find a better location or something else along these lines etc. I don't know how they'd call it, but the fact of the matter would be that they have been outflanked and removed from the market.

To sum up, perhaps it would be more helpful in your attempt to identify a specific configuration of a market if you could depart from a relatively well documented case and tried to work out the specifics from there.

  • 1
    $\begingroup$ "defer competition" - do you mean deter? $\endgroup$ – Adam Bailey Oct 27 '17 at 21:23

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