Price-Quantity Oligopoly with Adjustment Costs

Abstract

Economists have long discussed whether output or price is the “correct” decision variable for an oligopolistic firm. The earliest reference to this issue is probably Bertrand (1883); more recent contributors are Alger (1979), Shubik and Levitan (1980), Kreps and Scheinkman (1983), Davidson and Deneckere (1986), Benassy (1986a, 1986b), and Friedman (1988). In Friedman (1988) I analyzed three versions of an n-firm differentiated products oligopoly in which firms choose both prices and output levels, and firms that have not produced enough to meet their demand cause a spillover demand that benefits firms having excess production. Except for Benassy the papers listed above deal with homogeneous product duopoly. Benassy (1986b) is concerned with much the same questions as Friedman (1988) and he uses a similar framework. The present paper extends Benassy (1986b) and Friedman (1988) by allowing firms to adjust their output at some extra cost after obtaining price information. In Friedman (1988), three decision frameworks were examined: a) Game S, a model of simultaneous price and output choice, b) Game Q, a model of sequential choice. with output first, and c) Game P, a model of sequential choice with price first. In Benassy (1986b) frameworks (a) and (c) were examined. With attention restricted to pure strategy equilibria, the following results were obtained: An equilibrium never exists in the simultaneous choice model. In the output-first model, equilibrium may exist and, when it does, it coincides with the equilibrium of a straight output model. In the price-first model equilibrium may not exist and, when it does, it coincides with the equilibrium of a straight price model.*