DP5900 Mixed Oligopoly Equilibria When Firms' Objectives Are Endogenous

Author(s): Philippe De Donder , John E Roemer

Publication Date: October 2006

Keyword(s): mixed oligopoly , vertical differentiation , factions , party-unanimity Nash equilibrium

JEL(s): D21 , D43 , D62 , H82

Programme Areas: Industrial Organization , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP5900.asp.asp

We study a vertically differentiated market where two firms simultaneously choose the quality and price of the good they sell and where consumers also care for the average quality of the goods supplied. Firms are composed of two factions whose objectives differ: one is maximizing profit while the other maximizes revenues. The equilibrium concept we model, called Firm Unanimity Nash Equilibrium (FUNE), corresponds to Nash equilibria between firms when there is efficient bargaining between the two factions inside both firms. One conceptual advantage of FUNE is that oligopolistic equilibria exist in pure strategies, even though the strategy space (price, quality) is multi-dimensional. We first show that such equilibria are inefficient, with both firms underproviding quality. We then assume that the government takes a participation in one firm, which introduces a third faction, bent on welfare maximization, in that firm. We study the characteristics of equilibria as a function of the extent of government's participation. Our main results are twofold. First, government's participation in the firm providing the low quality good decreases efficiency while participation in the firm providing the high quality good increases efficiency. Second, the optimal degree of government's participation in the high-quality firm increases with how much consumers care for average equality.