Oligopoly Theory 　 1

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.

Oligopoly Theory 　 2

Outline of the 13th Lecture

13-1 Quality Improving Investment13-2 Optimal Investment under Monopoly 13-3 Incentive for Quality Investment with

Heterogeneous Consumers

Oligopoly Theory 　 3

High Quality Induces High Production Cost

MonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π=P(Y,I) Y-C(I)YTotal Social Surplus:∫0

YP(Y,I)dY-C(I)YMonopolist chooses Y and I.Question : Given the quality level, equilibrium output

level is (higher than, lower than, equal to) the social optimum level

Oligopoly Theory 　 4

Quality-Improving Investments

MonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π = P(Y,I)Y - CY - ITotal Social Surplus:∫0

YP(Y,I)dY – CY - IMonopolist chooses Y and I.Question : Given I, equilibrium output level is (higher

than, lower than, equal to) the social optimum level

Oligopoly Theory 　 5

Monopoly

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insufficient production

Oligopoly Theory 　 6

High Quality Induces High Production Cost

MonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π = P(Y,I) Y - C(I)YTotal Social Surplus:∫0

YP(Y,I)dY - C(I)YMonopolist chooses Y and I.Question : Given Y, equilibrium quality level is (higher

than, lower than, equal to) the social optimum level

Oligopoly Theory 　 7

Quality-Improving Investments

MonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π = P(Y,I)Y - CY - ITotal Social Surplus:∫0

YP(Y,I)dY - CY - IMonopolist chooses Y and I.Question : Given Y, equilibrium quality level is (higher

than, lower than, equal to) the social optimum level

Oligopoly Theory 　 8

High Quality Induces High Production Cost

MonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π=P(Y,I) Y - C(I)YFOC: (∂P/∂I)Y - C‘Y=0 (∂P/∂I)→How the quality improvement affects the

willingness to pay of the marginal consumer.Total Social Surplus:∫0

YP(Y,I)dY - C(I)YFOC: ∫0

Y(∂P/∂I)dY - C‘Y=0 ∫0

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

Oligopoly Theory 　 9

Quality-Improving InvestmentsMonopolyInvestment improves the quality of the product and

increases the demandProfit of the monopolist: Π = P(Y,I)Y - CY - IFOC: (∂P/∂I)Y - 1=0 (∂P/∂I)→How the quality improvement affects the

willingness to pay of the marginal consumer.Total Social Surplus:∫0

YP(Y,I)dY – CY - I∫0

Y (∂P/∂I)dY – 1 = 0 ∫0

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

Oligopoly Theory 　 10

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)

Oligopoly Theory 　 11

Question

Monopoly, Linear demandPayoff Π=(a(I) -Y) Y-C(I)YQuestion: The quality is (excessive, insufficient,

efficient) from the viewpoint of social welfare.

Oligopoly Theory 　 12

Quality-Improvement

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Oligopoly Theory 　 13

Quality ImprovementＰ

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

Oligopoly Theory 　 14

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.

Oligopoly Theory 　 15

Quality Improvement

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

Oligopoly Theory 　 16

Example of this caseOld 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.

Oligopoly Theory 　 17

Durable Goods MonopolyImprovement 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

Oligopoly Theory 　 18

Swan (1970)

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Oligopoly Theory 　 19

Non-Neutrality of DurabilityＰ

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Oligopoly Theory 　 20

Non-Neutrality of Durability

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Oligopoly Theory 　 21

Equivalence of Quality-Improving Investments and Cost-Reducing

InvestmentΠ = (a + f(I) - Y) Y - CY - IΠ = (a -Y)Y - (C - f(I))Y - IEssentially, 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.