Oligopoly theory 13 competition in q uality
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Oligopoly Theory (13) Competition in Q uality. Aim of this lecture (1) To understand the conditions under which equilibrium quality level is excessive. (2) To understand the neutrality result in the quality of product. 13-1 Quality Improving Investment

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Oligopoly Theory (13) Competition in Q uality

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Oligopoly theory 13 competition in q uality

Oligopoly Theory (13)Competition in Quality

Aim of this lecture

(1) To understand the conditions under which equilibrium quality level is excessive.

(2) To understand the neutrality result in the quality of product.


Outline of the 13th lecture

13-1 Quality Improving Investment

13-2 Optimal Investment under Monopoly

13-3 Incentive for Quality Investment with Heterogeneous Consumers

Outline of the 13th Lecture


High quality induces high production cost

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π=P(Y,I) Y-C(I)Y

Total Social Surplus:∫0YP(Y,I)dY-C(I)Y

Monopolist chooses Y and I.

Question : Given the quality level, equilibrium output level is (higher than, lower than, equal to) the social optimum level

High Quality Induces High Production Cost


Quality improving investments

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π = P(Y,I)Y - CY - I

Total Social Surplus:∫0YP(Y,I)dY – CY - I

Monopolist chooses Y and I.

Question : Given I, equilibrium output level is (higher than, lower than, equal to) the social optimum level

Quality-Improving Investments


Monopoly

Monopoly

insufficient production

MC

MR

0


High quality induces high production cost1

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π = P(Y,I) Y - C(I)Y

Total Social Surplus:∫0YP(Y,I)dY - C(I)Y

Monopolist chooses Y and I.

Question : Given Y, equilibrium quality level is (higher than, lower than, equal to) the social optimum level

High Quality Induces High Production Cost


Quality improving investments1

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π = P(Y,I)Y - CY - I

Total Social Surplus:∫0YP(Y,I)dY - CY - I

Monopolist chooses Y and I.

Question : Given Y, equilibrium quality level is (higher than, lower than, equal to) the social optimum level

Quality-Improving Investments


High quality induces high production cost2

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π=P(Y,I) Y - C(I)Y

FOC: (∂P/∂I)Y - C‘Y=0

(∂P/∂I)→How the quality improvement affects the willingness to pay of the marginal consumer.

Total Social Surplus:∫0YP(Y,I)dY - C(I)Y

FOC: ∫0Y(∂P/∂I)dY - C‘Y=0

∫0Y (∂P/∂I)dY/Y→ How the quality improvement affects the willingness to pay of the average consumer.

High Quality Induces High Production Cost


Quality improving investments2

Monopoly

Investment improves the quality of the product and increases the demand

Profit of the monopolist: Π = P(Y,I)Y - CY - I

FOC: (∂P/∂I)Y - 1=0

(∂P/∂I)→How the quality improvement affects the willingness to pay of the marginal consumer.

Total Social Surplus:∫0YP(Y,I)dY – CY - I

∫0Y (∂P/∂I)dY – 1 = 0

∫0Y (∂ P/∂I)dY/Y→ How the quality improvement affects the willingness to pay of the average consumer.

Quality-Improving Investments


Quality and welfare under monopoly

Quality and Welfare under Monopoly

The effect in the quality improvement to the willingness to pay of the marginal consumer <(>) the effect in the quality improvement to the willingness to pay of the average consumer

⇒Quality is insufficient (excessive) for social welfare ~ Spence (1967)


Question

Monopoly,

Linear demand

Payoff Π=(a(I) -Y) Y-C(I)Y

Question: The quality is (excessive, insufficient, efficient) from the viewpoint of social welfare.

Question


Quality improvement

Quality-Improvement

D’

0


Quality improvement1

Quality Improvement

Question: The quality is (excessive, insufficient, efficient) from the viewpoint of social welfare.

D’

0


Example of this case

Willingness to Pay ~ θq

q: quality, θ:the type of consumer, the value of the quality for the consumer

A consumer whose willingness to pay is higher evaluates the value of high quality more.

Example of this case


Quality improvement2

Quality Improvement

Question: The quality is (excessive, insufficient, efficient) from the viewpoint of social welfare.

D’

0


Example of this case1

Old consumer’s willingness to pay for the specific product of the firm is high (high brand loyalty). He(She) does not care about the quality.

Old consumer’s willingness to pay for the specific product of the firm is low (low brand loyalty). He(She) cares about the quality.

Example of this case


Durable goods monopoly

Improvement of durability→frequency of purchase is reduced→demand reduction

⇒The monopolist has a little incentive to improve the durability (has an incentive to produce the product that is likely broken in future)~It is not always true.

The improvement of durability increases the value of the product and thus it increases the willingness to pay for the product (increases the demand).

The monopolist produces the optimal quality product

Swan (1970)’s neutrality result.

However, this result is just a corollary of the general result of Spence

Durable Goods Monopoly


Swan 1970

Swan (1970)

D’

0


Non neutrality of durability

Non-Neutrality of Durability

D’

0


Non neutrality of durability1

Non-Neutrality of Durability

D’

0


Equivalence of quality improving investments and cost reducing investment

Equivalence of Quality-Improving Investments and Cost-Reducing Investment

Π = (a + f(I) - Y) Y - CY - I

Π = (a -Y)Y - (C - f(I))Y - I

Essentially, two are same problem, either in monopoly and oligopoly.

It is true even when the demand is non-linear if the quality improvement is equally evaluated by all consumers.


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