A theoretical and empirical study of the effect of product differentiation on collusion
This dissertation applies the supergame approach to a Salop type product differentiation model with n firms in the market. The theory shows that product differentiation facilitates the formation of tacit collusion among the firms in an oligopolistic industry. The empirical analysis finds that the product differentiation variable, average characteristic space per model of car, has a significant influence on the collusive behavior of the firms in U.S. automobile market from 1955 to 1984. The theory proves the existence of an optimal collusive price that maximizes collusive profits under the trigger strategy. The minimum discount factor that supports the collusive equilibrium is derived in terms of product differentiation factors. The relationship between product differentiation and the minimum discount factor is found by performing comparative statics analysis. Collusion becomes more difficult as products become better substitutes. A map of downward sloping convex curves of the minimum discount factor is drawn to show this relationship. Finally, the extreme cases of triopoly and duopoly are discussed and similar relationship between product differentiation and collusion is found. The minimum discount factor in a repeated game without product differentiation in previous literature is found to be a special case in our model with product differentiation. The empirical studies of this dissertation test the major outcome of the theory by using data on U.S. automobile industry from 1955 to 1984. Factor analysis is used to create market characteristic space by summarizing physical characteristics of cars. The regression analysis found that product differentiation is one of the significant factors affecting profit per unit of car and the enhanced competition in the market. Due to the increasing penetration of import cars and the response of the domestic producers, the characteristic space for each model of car in the U.S. automobile market shrank significantly during the period of study. These changes in product differentiation enhanced the competition in the industry.
Year of publication: |
1994-01-01
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Authors: | Zhang, Fan |
Publisher: |
Wayne State University |
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