DYNAMIC RETAIL PRICE AND INVESTMENT COMPETITION

We develop a model of retail competition in which retailers select pri ces and investments in cost reduction. An equilibrium is constructed i n which several identical firms enter and then engage in a phase of vi gorous price competition. This phase is concluded with a ''shakeout,'' as a low-price, low-cost firm comes to dominate the market. A central feature of the equilibrium is that low prices are complementary with large investments in cost reduction. Even though the dominant firm's p rice rises through rime, and initially may be below marginal cost, we argue that an interpretation of predatory pricing may be inappropriate .