Technical Note: Dynamic Duopolistic Competition with Sticky Prices

Steven Heston of the R.H. Smith School of Business at the University of Maryland, College Park, and Bo Hu of the Costello College of Business, George Mason University, resolve a puzzle about industrial competition in “Dynamic Duopolistic Competition with Sticky Prices.” Previous papers analyze the effect of frictions on competition in continuous time, such as sticky prices or transactions costs. Those papers conclude that miniscule frictions have a large impact on market prices and quantities. However, Heston and Hu show that these conclusions are an artifact of the continuous-time math. Heston and Hu use discrete-time models to analyze the effect of frictions that are small per unit of time. These models show the effect of small frictions is small.