When demand increases cause shakeouts

Abstract

Standard models that guide competition policy imply that demand increases should lead to more, not fewer firms. However, Sutton's (1991) model shows that demand increases instead can lead to shakeouts if non-price competition takes the form of fixed investments. We investigate this effect in the 1960s-1980s hotel and motel industry, where quality competition arose through investments in swimming pools. We show that demand increases associated with highway openings led to fewer firms, particularly in warm places. We do not find this effect in other industries that serve travelers, gasoline retailing, and restaurants, where quality competition does not involve fixed investments.