Abstract

Adding an intermediary stage where firms make R&D investments in product differentiation to the two stage model considered by Singh and Vives (1984) we obtain a three stage game where firms first choose their strategic variables (prices or quantities), then invest in R&D to reduce product substitutionability and finally compete on the market. We find that, depending on model parameters, all types of market competition can be an equilibrium. As market size increases, the game of choosing the strategic variable changes in structure. For small market size it is a dominance solvable game with Cournot competition as unique outcome – the same result found by Singh and Vives for substitute goods with exogenous product differentiation. For higher market size, the firms face a Prisoner’s Dilemma where Bertrand competition would be more profitable, but Cournot competition is the equilibrium because setting quantities against a price-setter is most profitable. For even higher market size we can have asymmetric pure-strategy equilibria where one firm sets quantities and the other sets prices. Finally, setting prices becomes the strictly dominant strategy and Bertrand competition the unique equilibrium outcome.  

Lunch will be provided for those attending the seminar.

For more information please contact Joep Lustenhouwer (J/K 2.09).