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Chapter 9
Oligopoly
OTHER DIMENSIONS OF COMPETITION Thus far, our focus has been on quantity and price competition within oligopolies. In this final section, we briefly consider two other forms of competition: strategic commitments and advertising.
Strategic Commitments A comparison of quantity competition and price competition yields a number of general propositions about the strategic actions and reactions of competing firms. Consider once again the case of symmetric firms competing with respect to quantities. A key part of that example was the way in which one firm’s quantity action affected the other’s—that is, how the competitor would be expected to react. If one firm (for whatever reason) were to increase its quantity of output, then the profit-maximizing response of the other would be to decrease its output. (Roughly speaking, the greater is one firm’s presence in the market, the less demand there is for the other.) Equation 9.3’s reaction function shows this explicitly. We say that the firms’ actions are strategic substitutes when increasing one firm’s action causes the other firm’s optimal reaction to decrease. Thus, the duopolists’ quantity decisions are strategic substitutes. By contrast, price competition works quite differently. If one firm changes its price (up or down), the optimal response for the competing firm is to change its price in the same direction. (One firm’s price cut prompts a price cut by its rival. Conversely, if one firm raises its price, the other can afford to raise its price as well.) The earlier example of Bertrand (winner take all) price competition exhibits exactly this behavior. Similar (but less dramatic) price reactions occur when competition is between differentiated products. (Here, a price cut by one firm will attract only a portion of the other firm’s customers and so prompts only a modest price reaction.) We say that the firms’ actions are strategic complements when a change in one firm’s action causes the other firm’s optimal response to move in the same direction. A comparison of competition between strategic substitutes and strategic complements leads to the following proposition. In a host of oligopoly models, competition involving prices (strategic complements) results in lower equilibrium profits than competition involving quantities (strategic substitutes). This result underscores the key difference between firm strategies under price competition and quantity competition. When firms compete along the price dimension, a rival’s lower price leads to the firm lowering its own price. In short, competition begets more competition. By contrast, under quantity competition,
