The Principle of Minimum Differentiation revisited: Return of the median voter

Abstract

We study a linear location model (Hotelling, 1929) in which n (with n ≥ 2) boundedly rational players follow (noisy) myopic best-reply behavior. We show through numerical and mathematical analysis that such players spend almost all the time clustered together near the center, re-establishing Hotelling's "Principle of Minimum Differentiation" that had been discredited by equilibrium analyses. Thus, our analysis of the best-response dynamics shows that when considering e.g. market dynamics as well as their policy and welfare implications, it may be important to look beyond equilibrium analyses.JEL Classification: C72, D72, L13, R30

Location choice with asymmetric data in the Hotelling model

“…However, d'Aspremont et al (1979) and Economides (1986) proved that there is no subgame‐perfect equilibrium under linear costs, while maximum differentiation occurs with quadratic costs. After that, different literature considers different settings, and the equilibrium exhibits either maximum (Economides, 1984; Neven, 1985) or minimum (Ahlin & Ahlin, 2013; Hanaki et al, 2019; Hehenkamp & Wambach, 2010; Rhee et al, 1992) differentiation. Different from these literatures, this paper finds that firms do not choose extreme locations under asymmetric data.…”

Introduction to special issue on “Complex evolving system approach to market dynamics and policy design”

“…The aggregate consequences of the actions and interactions of these boundedly rational decision makers can, sometimes, be in a sharp contrast with those under equilibrium analyses based on interaction among homogeneous rational agents with common knowledge assumption. Hanaki et al (2018) demonstrate such a contrast in their study of decision makers following noisy myopic best-reply behavior in a linear location model ( Hotelling, 1929 ). While equilibrium analyses suggest agents will be located far away from the center of the interval, noisy myopic best-reply behavior shows the opposite.…”