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Stability analysis in a Bertrand duopoly with different product quality and heterogeneous expectations

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  • Luciano Fanti
  • Luca Gori

Abstract

We study the local stability properties of a duopoly game with price competition, different product quality and heterogeneous expectations. We show that the Nash equilibrium can loose stability through a flip bifurcation when the consumer’s type range increases. This result occurs irrespective of whether the high(low)-quality firm has either bounded rational (naïve) or naïve (bounded rational) expectations about the price that should be set in the future by the rival to maximise profits. Therefore, although, on the one hand, an increase in the consumer’s types range increases profits, on the other hand, it contributes to reduce the parametric stability region of the unique interior equilibrium. Moreover, we show that the stability region is larger when the high-quality firm has naïve expectations and the low-quality firm has bounded rational expectations. This implies that when the expectations formation mechanism of the high-quality firm becomes more complicated than the naïve one, and, in particular, it follows the mechanism proposed by Dixit (1986), the stability of the Nash equilibrium in a duopoly market with price competition becomes under increasing strain.

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Paper provided by Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy in its series Discussion Papers with number 2011/122.

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Date of creation: 09 Jan 2011
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Handle: RePEc:pie:dsedps:2011/122

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Keywords: Bifurcation; Different product quality; Duopoly; Heterogeneous players; Price competition.;

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  1. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
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  9. Luciano Fanti & Luca Gori, 2011. "The dynamics of a Bertrand duopoly with differentiated products and bounded rational firms revisited," Discussion Papers 2011/120, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
  10. Tramontana, Fabio & Gardini, Laura & Puu, Tönu, 2009. "Cournot duopoly when the competitors operate multiple production plants," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 250-265, January.
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  15. Avinash Dixit, 1979. "A Model of Duopoly Suggesting a Theory of Entry Barriers," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 20-32, Spring.
  16. Tramontana, Fabio, 2010. "Heterogeneous duopoly with isoelastic demand function," Economic Modelling, Elsevier, vol. 27(1), pages 350-357, January.
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