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A dynamic model of quality competition with endogenous prices

Listed author(s):
  • Roberto Cellini

    ()

    (Department of Economics, University of Catania)

  • Luigi Siciliani

    ()

    (Department of Economics and Related Studies, University of York)

  • Odd Rune Straume

    ()

    (Universidade do Minho - NIPE)

We develop a dynamic model of price and quality competition in order to analyse the effects of competition intensity on quality provision and to which extent an unregulated market is able to provide a socially optimal quality level. Using a differential-game approach with price and quality competition on a Hotelling line, we compare the benchmark open-loop solution against the feedback closed-loop solution, which implies strategic dynamic interaction over time. We find that steady-state quality in the closed-loop solution is (i) increasing in the degree of competition between firms, (ii) lower than in the open-loop solution, and (iii) lower than the socially optimal level. In contrast, steady-state quality in the open-loop solution is at the socially optimal level and independent of competition intensity. Thus, our analysis identifies dynamic strategic interactions between competing firms as an independent source of inefficiency in quality provision.

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Paper provided by NIPE - Universidade do Minho in its series NIPE Working Papers with number 8/2015.

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Handle: RePEc:nip:nipewp:8/2015
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  1. Ching-to Ma & James Burgess, 1993. "Quality competition, welfare, and regulation," Journal of Economics, Springer, vol. 58(2), pages 153-173, June.
  2. Hinloopen, Jeroen, 2000. "Strategic R&D Co-operatives," Research in Economics, Elsevier, vol. 54(2), pages 153-185, June.
  3. Kurt R. Brekke & Luigi Siciliani & Odd Rune Straume, 2012. "Can competition reduce quality?," NIPE Working Papers 05/2012, NIPE - Universidade do Minho.
  4. Brekke, Kurt R. & Siciliani, Luigi & Straume, Odd Rune, 2010. "Price and quality in spatial competition," Regional Science and Urban Economics, Elsevier, vol. 40(6), pages 471-480, November.
  5. Siciliani, Luigi & Rune Straume, Odd & Cellini, Roberto, 2013. "Quality competition with motivated providers and sluggish demand," Journal of Economic Dynamics and Control, Elsevier, vol. 37(10), pages 2041-2061.
  6. Cellini, Roberto & Lambertini, Luca, 2009. "Dynamic R&D with spillovers: Competition vs cooperation," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 568-582, March.
  7. Araujo, Luis & Guimaraes, Bernardo, 2015. "Intertemporal coordination with delay options," Journal of Economic Theory, Elsevier, vol. 157(C), pages 793-810.
  8. Piga, Claudio A. G., 2000. "Competition in a duopoly with sticky price and advertising," International Journal of Industrial Organization, Elsevier, vol. 18(4), pages 595-614, May.
  9. Gravelle, Hugh, 1999. "Capitation contracts: access and quality," Journal of Health Economics, Elsevier, vol. 18(3), pages 315-340, June.
  10. Colombo, Luca & Labrecciosa, Paola, 2015. "On the Markovian efficiency of Bertrand and Cournot equilibria," Journal of Economic Theory, Elsevier, vol. 155(C), pages 332-358.
  11. Brekke, Kurt R. & Cellini, Roberto & Siciliani, Luigi & Straume, Odd Rune, 2010. "Competition and quality in health care markets: A differential-game approach," Journal of Health Economics, Elsevier, vol. 29(4), pages 508-523, July.
  12. Claudio A. Piga, 1998. "A Dynamic Model of Advertising and Product Differentiation," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 13(5), pages 509-522, October.
  13. Kurt R. Brekke & Roberto Cellini & Luigi Siciliani & Odd Rune Straume, 2012. "Competition in Regulated Markets with Sluggish Beliefs about Quality," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 21(1), pages 131-178, March.
  14. Vives, Xavier, 1985. "On the efficiency of Bertrand and Cournot equilibria with product differentation," Journal of Economic Theory, Elsevier, vol. 36(1), pages 166-175, June.
  15. Economides, Nicholas, 1993. "Quality variations in the circular model of variety-differentiated products," Regional Science and Urban Economics, Elsevier, vol. 23(2), pages 235-257, April.
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