Tamini, Lota D. (2012): Optimal quality choice under uncertainty on market development.
Download (299Kb) | Preview
This paper analyzes the impact of risk and ambiguity aversion - Knightian uncertainty - on the choice of optimal quality and timing of market entry. Irreversibility of the investment in product development is introduced in a continuous-time stochastic model applying the real option literature. We consider a market characterized by a duopoly with a Stackelberg-Nash game for quality choice. When the follower provides a higher-quality good, the level of quality is decreasing in ambiguity aversion while it is a non-monotonic function of the level of risk. For low levels of risk, the increase of product quality is an efficient response. Up to certain threshold level of risk, risk and ambiguity aversion reduce the optimal quality level and increase the value of waiting when the follower supplies a higher-quality good. The implication is that risk and ambiguity aversion allow the leader to make a sustainable monopoly profit. When the follower supplies a lower-quality good, there is no value for it to wait. It should therefore provide the lowest-quality good possible. In a vertically integrated supply chain firms provide higher quality, and the difference between vertically integrated and non-integrated firms is increasing in risk and ambiguity aversion.
|Item Type:||MPRA Paper|
|Original Title:||Optimal quality choice under uncertainty on market development|
|Keywords:||Quality, Duopoly, Real option, Vertical integration, Risk, Knightian uncertainty|
|Subjects:||D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L13 - Oligopoly and Other Imperfect Markets
L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality; Standardization and Compatibility
|Depositing User:||Lota Dabio Tamini|
|Date Deposited:||24. Aug 2012 11:22|
|Last Modified:||13. Feb 2013 02:22|
Aoki, R. and T.J. Prusa. 1997. Sequential versus simultaneous choice with endogenous quality. International Journal of Industrial Organization 15, 103-121.
Acemoglu, D.; P. Aghion; R. Griffith and F. Zilibotti. 2010. Vertical integration and technology: theory and evidence. Journal of the European Economic Association, 8, 989-1033.
Acemoglu, D., S. Johnson and T. Mitton. 2009. Determinants of vertical integration: financial development and contracting cost. The Journal of Finance, LXIV, 1251-1290
Asano, T. and A. Shibata. 2011. Optimal pricing and quality choice of a monopolist under Knightian uncertainty. International Journal of Industrial Organization 29, 746--754.
Bergemann, D. and J. Välimäki. 2002. Entry and vertical differentiation. Journal of Economic Theory 106, 91-125.
Bergès, F. and Z. Bouamra-Mechemache. 2012. Is producing private label counterproductive for a branded manufacturer? European Review of Agricultural Economics 39, 213-239.
Bewley, T.F. 2002. Knightian decision theory: Part I decision in economics. Finance 25. 70-110.
Bewley, T.F. 1989. Marketing innovation and entrepreneurship: A Knightian view. Discussion paper, Cowles Foundations.
Bewley, T.F. 2011. Knightian decision theory and econometric inferences. Journal of Economic Theory 146, 1134--1147
Carlton, D.W. and D.D. James Jr. 2008. Product variety and demand uncertainty: Why markups vary with quality. Journal of Industrial Economics 56, 535-552
Chen, Z. and L. Epstein. 2002. Ambiguity, risk and asset return in continuous time. Econometrica 70, 1403-1443.
Chevalier-Roignant, B, C.M. Flath, A. Huchzermeier and L. Trigeorgis. 2011. Strategic investment under uncertainty: a synthesis. European Journal of Operational Research 215, 639-650.
De Castro, L.I. and A. Chateauneuf. 2011. Ambiguity aversion and trade. Economic Theory 48, 243-273.
Dixit, A.K. and R.S. Pindyck. 1994. Investment under uncertainty. Princeton University Press, Princeton, New Jersey.
Economides, N. 1999. Quality choice and vertical integration. International Journal of Industrial Organization 17, 903-914.
Ellsberg, D., 1961. Risk, ambiguity, and the savage axioms. Quarterly Journal of Economics 75, 643--669.
Gervais, J-P. and R. Lambert. 2010. The simple economics of hog marketing reforms in Québec. SPAA Network Working paper, 2010-01.
Ghazalian, P.L. 2012. Home Bias in Primary Agricultural and Processed Food Trade: Assessing the Effects of National Degree of Uncertainty Aversion. Journal of Agricultural Economics 63, 265-290.
Gilboa, L. 2009. Theory of decision under uncertainty. Cambridge University Press.
Häckner, J. A 2000. Note on price and quantity competition in differentiated oligopolies, Journal of Economic Theory 93, 233-239.
Handley, K. and N. Limão. 2012.Trade and investment under policy uncertainty: Theory and Firm Evidence. NBER Working Paper No. 17790.
Hofstede, G.H., 1980. Culture's consequences: International differences in work-related values. Sage, Thousand Oaks, CA.
Hofstede, G.H., 2001. Culture's consequences: Comparing values, behaviors, institutions, and organizations across nations. Sage, Thousand Oaks, CA.
Huang, R.R., 2008. Tolerance of uncertainty and the growth of informationally opaque industries. Journal of Development Economics 87, 333--353
Huang, R.R. 2007. Distance and Trade: Disentangling unfamiliarity effects and transport cost effects. European Economic Review 51, 161-181.
James Jr, H.S., M.K. Hendrickson and P.H. Howard. 2012. Networks, Power and Dependency in the Agrifood Industry. Department of Agricultural & Applied Economics Working Paper . Available at SSRN: http://dx.doi.org/10.2139/ssrn.2004496
James Jr, H.S., P.G. Klein and M.E. Sykuta. 2011. The adoption, diffusion and evolution of organizational form: insight from the agrifood sector. Managerial and Decision Economics 32: 243-259.
Kong, J.J. and Y.K. Kwok. 2007. Real option in strategic investment game between two asymmetric firms. European Journal of Operational Research 181, 967-985.
Lavoie, N. 2005. Price Discrimination in the Context of Vertical Differentiation: An Application to Canadian Wheat Exports. American Journal of Agricultural Economics 87: 835-854.
Lopez, R.A., A.M. Azzam and C. Liron-Espana. 2002. Market power and/or efficiency: A structural approach. Review of Industrial Organization 20, 115-126.
Maggi, G. (1999). The Value of commitment with imperfect observability and private information. Rand Journal of Economics 30, 555-574.
MAPAQ [Ministère de l'Agriculture, de l'Alimentation et des Pêcheries du Québec]. 2010. Monographie de l'industrie porcine québécoise. Available at http://www.mapaq.gouv.qc.ca/fr/ Publications/monographieporc_finale%282%29.pdf. Accessed May 9, 2012.
Miao, J. and N. Wang. 2011. Risk, uncertainty, and option exercise. Journal of Economic Dynamics and Control 35, 442-461.
Möhlmann, L.J.; S. Ederveen; H.L.F de Groot and G-J M Linders. 2010. Intangible barriers to international trade. A Sectoral approach. In Gravity Model in International Trade. Advances and Applications. P.A.G. van Bergeijk and S. Brakman eds. 224-251.
Moreto, M. 2008. Competition and irreversible investments under uncertainty. Information Economics and Policy 20, 75-88.
Mussa, M. and S. Rosen. 1978. Monopoly and product quality. Journal of Economy Theory 18, 301-317.
Nishimura, K.G. and H. Ozaki. 2007. Irreversible investment and Knightian uncertainty. Journal of Economic Theory 136, 668 -- 694.
Pawlina, G. and P.M. Kort. 2010. Strategic quality choice under uncertainty: a real option approach. The Manchester School 78, 1-19.
Pennings, E. 2004. Optimal pricing and quality choice when investment in quality is irreversible. Journal of Industrial Economics 52, 569-589.
Rigotti, L. and C. Shannon. 2005. Uncertainty and risk in financial market. Econometrica 73, 203-243.
Sadanand, A. and V. Sadanand. 1996, Firm scale and endogenous timing of entry: a choice between commitment and Flexibility, Journal of Economic Theory 70, 516--530.
Santiago, B. 2011. Product differentiation and systematic risk: theory and empirical evidence. Unpublished paper.
Scherer, F., 1980, Industrial market structure and economic Performance Chicago: Rand McNally.
Shaked, A. and J. Sutton. 1982. Relaxing price competition through product differentiation. Review of Economic Studies 49, 3-13.
Sheldon, I.M. and B.E. Roe 2009. Public vs private eco-labelling of environmental credence goods: maximizing the gains from international integration. Journal of Agricultural Food Industrial Organization 7, Article 4.
Spence, M. 1975. Monopoly, quality and regulation. Bell Journal of Economics 6, 417-429.
Stoye, J. 2012. New Perspectives on Statistical Decisions Under Ambiguity. Annual Review of Economics 4:1.1--, 1.26.
Uppal, R. and T. Wang. 2003. Model misspecification and under diversification. Journal of Finance 48, 2465--2486.
Wang, Z. 2010. Irreversible investment of the risk- and uncertainty averse DM under k-ignorance: the role of BSDE. Annals of Economics and Finance 11, 313-335.
Weeds, H. 2002. Strategic delay in real option model of R&D competition. Review of Economic Studies 69,729-747.