Multiproduct Firms with Vertical Product Differentiation
Date Issued
2010
Date
2010
Author(s)
Cheng, Yi-Ling
Abstract
The literature on vertical product differentiation often makes the assumption that any one firm can produce only one product. Although this is analytically convenient, in reality, firms normally produce and sell multiple differentiated products. Therefore, the purpose of this dissertation is to investigate the product differentiation between firms as each of them may produce multiple quality-differentiated products.
Chapter 2 proposes a Cournot model of two-stage competition to examine the characteristics of vertical product differentiation in a multiproduct duopoly. Firms choose the number of products/varieties (with a maximum of two) and their qualities, and then compete in quantities. We first show that, in the equilibrium of a natural monopoly, the monopolist must sell a single product. Moreover, in the equilibrium of a multiproduct duopoly, there are asymmetric equilibrium outcomes with non-segmented patterns of differentiation. They are in sharp contrast with the symmetric outcomes when increasing the number of products is assumed to be costless. We also find that the product differentiation in the high-quality market is smaller than that in the low-quality one, and the product differentiation within a firm is greater than that between firms.
In Chapter 3, we characterize the equilibrium of a two-stage game where firms simultaneously choose the number of varieties (with a maximum of two) and associated qualities at the first stage, and compete in prices at the second stage. The result also shows that a natural monopolist never sells multiple varieties. However, in the equilibrium of a multiproduct duopoly, there are always segmented patterns of vertical differentiation. Sandwich, enclosure and interlacing configuration never emerge, because each firm has incentive to reduce the number of products facing head-to-head competition with the rival, in order to avoid keen price competition. The result also shows that the product differentiation of neighboring varieties between firms is greater than that within a firm. In addition, we find that the emergence of multi-quality equilibrium crucially depends on the nature of costs of quality. While the cost of quality falls on the fixed production costs (rather than the variable costs), each firm always produces a single quality of products.
In Chapter 4, we investigate a two-stage competition in a vertical differentiated industry, where each firm produces an arbitrary number of similar qualities and sells them to heterogeneous consumers. The number of products, qualities, prices, and the extent of the market coverage are endogenously determined. We show that, when unit costs of quality improvement are increasing and quadratic, each firm has an incentive to provide an interval of qualities. The finding sharply contrasts to the single-quality outcome when the market coverage is exogenously determined. We also show that allowing for an interval of qualities intensifies the level of competition, lowers the profit of each firm, and raises the consumer surplus and the social welfare in comparison to the single-quality duopoly.
Chapter 5 concludes and provides some extensions of this research.
Subjects
Multiproduct Firms
Quality Competition
Vertical Product Differentiation
Market Segmentation
Bertrand Competition
Cournot Competition.
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