21 Inperfect Competition 2

# 21 Inperfect Competition 2 - Topic 9 Competition between...

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4/7/2009 1 Topic 9: Competition between firms (2) USC Marshal Models of product differentiation Models of product differentiation Competition with differentiated products: – Products are rarely perfectly homogeneous • An IBM is not a Dell • A BMW is not a Mercedes •P laystation is not an Xbox USC Marshal • Coke is not Pepsi •… – Consequence: raising price a little bit will not cause the firm to lose all its demand Models of product differentiation Example: – IBM and Dell are choosing how much to charge for their computers – Demands: Q Dell d 30 2 P Dell P IBM USC Marshal – Marginal cost c of producing a computer is 1 – Profit for each: Q IBM d 30 2 P IBM P Dell IBM P IBM 1  30 2 P IBM P Dell Dell P Dell 1  30 2 P Dell P IBM

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4/7/2009 2 Models of product differentiation Solution: Step 1: Profit functions Step 2: Reaction functions USC Marshal Step 3: Nash equilibrium Models of product differentiation P IBM BR IBM (P Del ) USC Marshal P Del BR Del (P IBM ) Models of product differentiation • Suppose that IBM and Dell merged. How would the equilibrium prices change? – Changes the objective to maximizing joint profits P IBM 1  30 2 P IBM P Dell P Dell 1  30 2 P Dell P IBM USC Marshal – Solution: Logic: • The two products are substitutes. When pricing independently, the firms don’t internalize the increase in demand (and so profit) experienced by the other firm following a price increase P IBM P Dell 15 1 2
4/7/2009 3 Models of product differentiation P IBM BR IBM (P Del ) USC Marshal P Del

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21 Inperfect Competition 2 - Topic 9 Competition between...

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