Ruhr Economic Papers

Ruhr Economic Papers #666

The Different Effect of Consumer Learning on Incentives to Differentiate in Cournot and Bertrand Competition

by Maximilian Conze and Michael Kramm

RGS, TUD, 01/2017, 26 S./p., 8 Euro, ISBN 978-3-86788-773-1 DOI: 10.4419/86788773

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Abstract

We combine two extensions of the differentiated duopoly model of Dixit (1979), namely Caminal and Vives (1996) and Brander and Spencer (2015a,b), to analyze the effect of consumer learning on rms’ incentives to differentiate their products in models of Cournot and Bertrand competition. Products are of different quality, consumers buy sequentially and are imperfectly informed about the quality of the goods. Before simultaneously competing in quantities, firms simultaneously choose their investment into differentiation. Late consumers can observe earlier consumers’ decisions and extract information about the quality of the goods. This influences the firms’ incentives to differentiate. If firms compete in quantities, they are more likely to invest in differentiation with consumer learning than without. This is in line with implications of the recommendation effect introduced in Conze and Kramm (2016) in a model of spatial differentiation. We also examine the case in which firms compete in prices. Here, the effect of consumer learning is reversed, so that differentiation is less likely with consumer learning. Thus, we find an information-based difference between Cournot and Bertrand competition: in the Bertrand setting consumer learning increases the competition, i.e. products are more likely to be substitutes, and it weakens it in the Cournot model.

JEL-Classification: L13, L15, D83

Keywords: Principle of minimum differentiation; consumer learning; Bayesian observational learning

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