9781118041581

OTHER DIMENSIONS OF COMPETITION

Thus far, our focus has been on quantity and price competition within oligop-

olies. 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 num-

ber of general propositions about the strategic actions and reactions of com-

peting 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 pres-

ence 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 substituteswhen 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 complementswhen a change in one firm’s action causes the other

firm’s optimal response to move in the samedirection.

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 comple-

ments) 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 begetsmore competition. By contrast, under quantity competition,

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