Endogenous Quality Choice: Price and Quantity Competition

Selim, Tarek (2004): Endogenous Quality Choice: Price and Quantity Competition. Published in: Economics Bulletin , Vol. 28, No. 3 (May 2004)

Abstract

The present paper is concerned with providing a core model to address the issue of firms simultaneously competing in both prices and quantities (capacity levels) within a simple duopoly market setting where products are asymmetrically differentiated by endogenous quality location. A three-stage competitive framework is introduced such that non-collusive firms compete in quality location, followed by choice of fixed capacity, and finally, they compete in prices. There is a continuum of consumers uniformly distributed along a vertical quality street of product locations. In general, a Bertrand-Nash equilibrium with fixed Cournot quantities (fixed capacity) is achieved. Firms tend to move away from minimum differentiation as quality cross-effects in fixed cost investments become less severe, but not necessarily choosing quality locations which would lead towards an outcome of maximum differentiation. An output asymmetry always exists at equilibrium such that the high quality firm always carries excess production capacity relative to the low quality firm. Total production capacity, however, may not fully cover market demand for an incumbent duopoly.

• Item Type: MPRA Paper
• Language: English
• Keywords: Product differentiation, Duopoly, Bertrand prices, Nash equilibrium, Cournot capacity, Market Entry, Uncovered market, endogenous choice, vertical location, Quality signals, Competition games, Multi-stage model
• Subjects: C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C72 - Noncooperative Games; D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior: Theory; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D43 - Oligopoly and Other Forms of Market Imperfection; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality ; Standardization and Compatibility; L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L23 - Organization of Production

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