Other Dimensions of Competition 377a rival’s increase in output induces a lower quantity of output by the firm itself.
In this sense an increase in output detersa competitive response. In general,
price competition is more intense than quantity competition (which is self-lim-
iting). The upshot is that equilibrium price setting tends to lead to lower prof-
its for the firms than equilibrium quantity setting.
Of course, it is important to keep this result in perspective. Price com-
petition is not always destructive; the particular equilibrium outcome
depends, as always, on underlying demand and cost conditions. (For instance,
Check Station 3 displays favorable demand conditions in which equilibrium
behavior leads to highprices.) In other words, the comparison of equilibrium
outcomes requires holding other factors constant. (End-of-chapter Problems
9 and 10 provide a good example of this.) The result does suggest an inter-
esting strategic message. Frequently, firms find themselves surveying any
number of strategic dimensions—price, quantity, advertising, and so on—
and have the opportunity to “pick their battles.” Most oligopoly models sug-
gest that it is wise to avoid price competition (because this involves strategic
complements) and to compete on quantity and advertising (where both
involve strategic substitutes).COMMITMENTS Suppose a firm is about to engage in quantity competition
but also faces an earlier decision. For instance, the firm has the opportunity to
invest in a new production process that has the advantage of lowering its mar-
ginal cost of production. Should the firm commit to this process investment?
A complete answer to this question depends on anticipating the investment’s
effect on the subsequent quantity competition. Looking just at the firm’s own
behavior, we know that the lower marginal cost induces a higher optimal out-
put. But the strategic effect also matters. Because the firms’ quantities are
strategic substitutes, an increased output by the first firm will induce a lower
output by the rival. This reduction in competing output further spurs the firm
to greater output and increases its profitability. (Check Station 1 provides a
good example of these equilibrium output effects.) In short, the original com-
mitment to invest in capacity might well be profitable exactly becauseof its strate-
gic effect on competitor behavior.
Economists Drew Fudenberg and Jean Tirole have explored the general prin-
ciples underlying this example.^10 When the subsequent competition involves
strategic substitutes, a tough commitment by one of the firms will advanta-
geously affect the ensuing equilibrium. Here, toughdenotes any move that
induces an increase in the firm’s own output and (in turn) a decrease in the
rival’s output. Making product quality improvements, increasing advertising(^10) See D. Fudenberg and J. Tirole, “The Fat-Cat Effect, the Puppy-Dog Ploy, and the Lean and
Hungry Look,” American Economic Review(1984): 361–366. An additional source is J. Bulow, J.
Geanakopolos, and P. Klemperer, “Multimarket Oligopoly: Strategic Substitutes and
Complements,” Journal of Political Economy(1985): 488–511.
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