Intermediation by Heterogeneous Oligopolists

In his book on “Market Microstructure” Spulber presented some strange results with respect to the impact of the substitutability parameter in an intermediation model with differentiated products and inputs. Intuitively, effects in the product and the input market should be similar: if firms become more homogeneous, they loose market power, which should yield lower bid-ask-spreads and higher output. However, in Spulber’s analysis parameter changes in the product market yield qualitatively different results for bid–ask spreads and output than equivalent changes in the input market. The present paper shows that this outcome stems from an inadequate normalization of market size in upstream and downstream markets, respectively. By appropriately controlling for market size effects, intuitive results are obtained. Beyond that, a setting with appropriate normalization also allows to address the impact of changes in the number of competitors on the market outcome.