Markups and Entry in a Circular Hotelling Model

The Hotelling locational model and its adaptations to a circular city provide a core framework for research in industrial organization. The present paper expands the explanatory power of this model by incorporating a continuum of consumers with constant-elasticity demand functions along with stores that have constant marginal costs of production. The stores are evenly spaced in equilibrium. The model generates a simple formula in which the markup of price over marginal cost depends on the spacing between stores and a transportation-cost parameter but is independent of the elasticity of demand. This result reflects pricing decisions by stores that factor in the threat of losing business entirely at the borders with neighboring stores. The free-entry solutions for the number of stores and their spacing approximate socially optimal values but quantities of goods consumed are inefficiently low.