Price competition vs. quantity competition: the role of uncertainty

Abstract

We analyze the Nash equilibria of a one-stage game in which the nature of the strategic variables (prices or quantities) is determined endogenously. Duopolists producing differentiated products simultaneously choose either a quantity to produce or a price to charge. In the absence of exogenous uncertainty, there exist four types of equilibria with differing levels of output: (price, price), (quantity, quantity), (price, quantity), and (quantity, price). The multiplicity of equilibria stems from each firm's indifference between setting price and quantity, given its conjecture about its rival's strategy. But exogenous uncertainty about market demands, which makes firms uncertain about their residual demands, even in equilibrium, gives firms strict preferences between setting price and quantity. As a result, the number of equilibria is reduced. When uncertainty is exogenous, we analyze the effect of the slope of marginal costs, the nature of the demand disturbance, and the curvature of demand on firms' propensities to compete with price or quantity as the strategic variable. These three factors are likely to influence the nature and intensity of oligopolistic competition. Introduction Economists using games to represent oligopolistic competition debated the relative merits of models using prices or quantities as firms' strategic variables from as early as Bertrand's (1883) criticism of Cournot (1838). The extent to which firms can choose price or quantity must, of course, crucially affect the nature of competition. If they have some choice, however, the extent to which firms want to choose price or quantity may be important.