Idiosyncratic Tastes in an Oligopoly Model

+
Alessandro Bonatti
Yale University
February 2, 2006
Abstract
This paper develops a competitive screening model in which rms face buyers with multi-
dimensional types and private information. Its approach diers from (that of) discrete-choice
models of product dierentiation. It is assumed that buyers have idiosyncratic tastes, i:e: dier-
ent marginal utilities for consuming products of dierent brands. The symmetric equilibria for
the duopoly and oligopoly cases are derived and some mechanism design issues that arise in this
context are discussed. The equilibrium allocations are similar to the traditional monopoly case
but they are characterized by the provision of more ecient quality levels. These allocations are
also shown to dier substantially from those of discrete - choice, random participation models.
1 Introduction
This paper analyzes an oligopoly model with adverse selection in which sellers use nonlinear prices
to compete over a buyer with multidimensional characteristics. The buyer has private information
over her preferences, namely on the marginal utilities she derives from the quality of each sellers
product. These marginal utilities are allowed to depend on the products brand. In this sense, the
buyer displays idiosyncratic tastes.
From a more general perspective, this paper describes a game of common agency with an ex-
clusive dealing clause. In the absence of dierentiation in product characteristics or in consumers
demand functions (due for example to idiosyncratic tastes), this is essentially a game of price com-
petition. As such, it displays an equilibrium la Bertrand with zero-prots and fully competitive
(ecient) quality supply. One of the main goals of the literature on competitive price discrim-
ination (surveyed by Stole [10]) is to study the conditions that allow to capture more realistic
aspects of nonlinear taris in strategic environments. A successful approach, in part borrowed
from the empirical literature on industries with market power (surveyed by Bresnahan [3]), is that
of dierentiated products.
In a discrete-choice model of product dierentiation each consumers net utility from choosing
rm j is determined by the (quality, tari) bundle she chooses and by an additive, rm-specic,

For many helpful discussions, I wish to thank (in alphabetical order): Luigi Balletta, Dirk Bergemann, Dino
Gerardi, Marco Pagnozzi and Maher Said.
1
xed component (Stole [10]). The xed component varies across the population of consumers.
The frequently-used functional form for the demand function separates horizontal brand preference
from vertical taste for quality.
1
This specication allows to tractably model the consumers choices
from dierent brands product lines. However, it assumes a distribution of preferences under which
the relative value of purchasing similar items from two brands is independent of the products
quality. The automobile industry is often used as an example (see Berry et al. [2]). In this market,
consumers can be thought of having brand preferences (e:g: BMWs over Mercedes) that determine
their choice among products of similar quality and dierent brand. In this setting, the choice of an
item within a brands product line depends only on the buyers taste for quality. This means that
buyers marginal taste for quality does not dier across brands.
However, one may think about dierent complementary aspects to this problem. Again with
reference to the automobile industry, consider the value of optional items in a car (e:g: leather
seats in BMWs as opposed to Fords). This kind of choice is determined by the additional value
the consumer attributes to optional items when she is already (considering) buying a given brands
product. The same could hold true when thinking about upgrading ones choice within a given
brands product line (what is the additional value of a more powerful model?). Therefore this choice
may be better modeled with the introduction of brand-specic taste for quality (marginal utility).
2
This paper characterizes the symmetric equilibria of an oligopoly model when buyers display
idiosyncratic tastes. In equilibrium, sellers oer menus of contracts that share the main qualitative
features of the Mussa-Rosen [7] (henceforth MR) monopoly allocation
3
. Competition among sellers,
however, reduces quality distortions and increases the agents rents. These eects are even stronger
when the buyers types are positively correlated and when the number of sellers increases. Clearly,
a useful exercise would involve integrating the idiosyncratic tastes approach into a discrete-choice
/ random participation setup, so to better describe the buyers choice within and among menus
of contracts. However it is unclear at this stage whether the two approaches can be tractably
combined.
The rest of this paper is organized as follows: section 2 reviews two papers very closely related
to this one; section 3 introduces the model; section 4 discusses the main assumptions; section 5
derives the equilibrium contracts in a duopoly model and compares it to results in the literature;
section 6 provides extensions, e.g. to an oligopoly setting; section 7 concludes.
1
To be more precise, a typical formulation of the utility function is
Uij = iqj pj + xij
where i is consumer is taste for (vertical) quality and xij is her additive shock to purchasing from rm j:
2
To anticipate the formulation of the utility function:
Uij = ijqj pj:
where ij is consumer i
0
s taste for the quality of rm j
0
s products.
3
The distinctive features of the monopoly MR allocation with one-dimensional types can be summarized as follows:
Lowest type (L) receives her reservation utility level (e.g. U (L) = 0).
Highest type (H) receives ecient quality provision (q (H) = H) :
Quality is distorted downwards everywhere else.
2
2 Literature Review
The two papers most closely related to the present one are those by Armstrong and Vickers [1]
(henceforth AV) and by Rochet and Stole [8] (RS). Both AV and RS adopt a formulation for the
buyers utility function that is reminiscent of discrete-choice models. This formulation introduces
randomness in the agents participation decision through type-independent stochastic reservation
utilities. This framework is then applied to both a monopoly and an oligopoly model. Random
participation proves to bear two distinct eects in these two settings. In the monopoly case, it
rationalizes nonlinear tari schemes that assign positive rent (utility) to every consumers (so to
insure positive probability of participation). For the oligopoly case, random participation eectively
introduces spatial dierentiation among sellers, thus relaxing price competition. If dierentiation is
small enough, the equilibrium quality supply proves to be the ecient (rst best) one. Otherwise,
distortions persist, though they prove to be lower under competition than in the monopoly case
(this last result is specic to RS). In either case, all rms obtain positive prots.
The basic technique used in these papers is to dene buyers with multidimensional types indi-
cating, roughly speaking, horizontal and vertical taste parameters. The buyers type is assumed to
be a vector ((x
1
; ::x
N
) ; ) where x
j
is her reservation utility when dealing with seller j: It then fol-
lows that having a population with a continuum of types (x; ) for a given is equivalent to facing a
single buyer who receives random outside options. The key assumption in both AV and RS is that
the horizontal and vertical taste parameters ((x
1
; ::; x
N
) ; ) are independently distributed. The
optimal selling mechanisms can then be derived using the traditional tools of single-dimensional
screening via an exclusive dealing assumption and a restriction to deterministic contracts. With
these assumptions, the seller can adopt a direct revelation mechanism in which the buyer is only
asked to report her vertical taste parameter.
This paper adopts a similar simplied approach to the multidimensional screening problem
(section 3) and argues that this type of approach to common agency games with exclusive dealing
clauses is actually general.
3 The Model
This section introduces the main features of an oligopoly model in which buyers have idiosyncratic
taste for quality. More specically, let J =1; :::; I be the set of (identical) sellers. Let there be
a continuum of buyers with types = (
1
; ::;
I
)
I
i=1
[
L
;
H
] : Dene the utility type receives
when consuming a good of quality q
i
produced by rm i is equal to
U
i
() =
i
q
i
p
i
Each component of the buyers type
i
is identically and independently distributed over [
L
;
H
]
according to a continuously dierentiable distribution function F (
i
) ; with density f (
i
) :
3
3.1 Simple Pricing Game
In order to illustrate the main mechanisms at work in this model, assume that rms can only
produce one quality of the good. For simplicity, let this quality level be q
i
= 1 for all i; normalize
production costs to zero and let the type space be = [0; 1]
I
: Firm is strategy consists therefore
of naming a single price p
i
: This section characterizes the symmetric equilibrium of this game.
In this simplied setting, the utility of a type consumer given a strategy prole p R
I
can
be written as:
U (; p) = max
i2I
(
i
p
i
)
Therefore, each sellers expected prot is equal to
E [V
i
(p)] = p
i
Pr
_

i
p
i
> max
j6=i
(
j
p
j
)
_
Notice that a type buyer will prefer the product of rm i over that of rm j if
j
_
i
p
i
+p
j
: It
follows that

j6=i
F (
i
p
i
+ p
j
) is the fraction of types (
i
; ) that purchase from rm i: Denote
the k-th order statistics of F and f by F
I
k
(
i
) and f
I
k
(
i
) : The solutions to programs (1) and (3)
can be then derived as follows.
Competitive Case: Under price competition, seller i solves the following program:
max
p
i
2[0;1]
_
1
p
i
p
i

j6=i
F (
i
p
i
+ p
j
) f (
i
) d
i
(1)
The symmetric equilibrium of the competitive pricing game p

is characterized by the rst-order

condition
1 F
I
1
(p

)
I

1
I
p

f
I
1
(p

) p

_
1
p

f
I1
1
() f () d = 0 (2)
Collusive Case: If sellers collude to maximize joint prots, then the (collusive) equilibrium
price solves:
max
p
i
2[0;1]
_
1
p
i
p
i
[F (
i
)]
I1
(
i
) f (
i
) d
i
(3)
The equilibrium of the collusive pricing game p
C
is characterized by
1 F
I
1
_
p
C
_
I

1
I
p
C
f
I
1
_
p
C
_
= 0 (4)
In words, condition (2) states that when setting her price, each seller optimally trades o the prot
margin on the units sold
_
1F
I
1
(p

)
I
_
with loss in market share due to her own price raise
_
1
I
p

f
I
1
(p

)
_
and to competing sellers
_
p

_
1
p

f
I1
1
() f () d
_
: The latter (strategic) eect is clearly absent in
4
the characterization of the collusive price (4). It can be shown that the competitive and collusive
prices respond dierently to an increase in the number of rms.
Proposition 1 The collusive price p
C
(I) is always increasing in I: The competitive price p

(I) is
decreasing in I if the distribution of types satises the condition:
f (p)
F (p)
_
1
I
\p (5)
Proof. See the Appendix
Intuitively, colluding rms will try to capture the rents associated with the buyers who value
their products the most, provided that collusive agreements prevent other rms from challenging
their prices. The sucient condition (5) states that if there is enough probability density at the
upper end of the distribution, then the induced competition among sellers drives the equilibrium
price down as the number of sellers increases. It is worth pointing out that the uniform distribution
over the unit support satises (5) while the standard normal does not. Nevertheless, under both
distributions, the (competitive) equilibrium prices are decreasing in the number of rms, suggesting
that (5) is perhaps too restrictive a condition. The equilibrium prices for these distributions are
shown on the following graph:
60 50 40 30 20 10
1
0.75
0.5
0.25
0
I
p(I)
I
p(I)
Equilibria of Pricing Game for Standard Normal (upper)
and Uniform (lower) distributions
3.2 Nonlinear Pricing
This section introduces competition with nonlinear tari schemes. Consider the same set of I
sellers, each of whom can produce a good of quality q
i
at a cost of c (q
i
) = q
2
i
=2. Seller i oers the
buyer a nonlinear tari scheme (menu of contracts) of the form q
i
; p
i
(q
i
) : The analysis is carried
5
out under three important assumptions. They are stated here and will be discussed in detail in the
following section.
(A1) Restrict attention to deterministic contracts
(A2) Direct revelation mechanisms under which the buyer only reports
i
to seller i:
(A3) Exclusive dealing: buyers can only buy from one seller.
Under A1 A2; the utility function of a type - buyer when dealing with rm i can be written
in the usual form
U
i
_

i
;
^

i
_
=
i
q
i
_
^

i
_
p
i
_
^

i
_
Therefore, the sucient conditions for global Incentive Compatibility (for seller i) are given by:
dU
i
(
i
;
i
)
d
i
= q
i
(
i
)
dq
i
(
i
)
d
i
_ 0
The value of the buyers outside option is normalized to zero. Therefore the Individual Rationality
constraint can be written as:
U
i
(
i
;
i
) _ 0
As in the simple pricing game, x a prole q
i
(
i
) ; U
i
(
i
)
I
i=1
of incentive-compatible menus and a
seller i. Dene (I 1) indierent types
_

j
(
i
)
_
j6=i
the cuto types
j
that satisfy the condition
4
:
U
i
(
i
) U
j
_

j
(
i
)
_
= 0 (6)
Therefore, in this framework,

j6=i
F
_

j
(
i
)
_
is the fraction of types (
i
; ) that choose to purchase
from rm i: For a given strategy prole q
i
(
i
) ; U
i
(
i
)
I
i=1
, seller i
0
s expected prots can then be
written as follows:
_

H

L
_

i
q
i
(
i
)
q
i
(
i
)
2
2
U
i
(
i
)
_

j6=i
F
_

j
(
i
)
_
f (
i
) d
i
4 Discussion of Main Assumptions
The approach adopted in this paper to derive an equilibrium of an oligopoly model with nonlinear
pricing relies heavily on assumptions A1 and A2: In other words, the generality of the results
presented in the following sections is potentially reduced by the restriction to deterministic contracts
4
More precisely, let x be the solution to (6) and dene

j
:= min f1; max fx; 0gg :
6
and to partial-revelation direct mechanisms. The main eect of these assumptions is to allow an
adaptation of traditional techniques from single-dimensional screening problems (see e.g. Salani
[9]) to solve for the symmetric equilibrium in a game with competing principals. At least two
mechanism design issues are relevant in this context: (a) the Revelation Principle generally fails
in such common agency games; (b) in a multidimensional types setting, the optimal contract may
require principals to oer lotteries rather than deterministic (p; q) allocations. At this stage, it is
important to discuss these issues and to argue informally that assumptions A1 A2 do not reduce
the generality of the approach.
4.1 The Revelation Principle
In most common agency games, restricting attention to truthful equilibria of direct mechanisms
entails loss of generality. The reasons for this failure are eectively summarized in Martimort [5].
For the purpose of this paper, it is enough to point out that the richness of the space of mechanisms
available to the principals depends on the richness of the message space
5
. When oering menus of
contracts to the same buyer, the latters messages could convey useful market information on the
taris shes being oered by other principals. It can be argued that in this setting the Revelation
Principle holds despite this source of complexity.
In fact, it is sucient to observe that the contracts oered by one principal do not create any
direct or indirect externality on the other principals. The reason for this is that the utility levels
principals oer to the agent only aect her participation decision, not her optimal choice within any
principals menu of oers. More in depth, Martimort and Stoles [6] Delegation Principle
6
can be
applied. In the light of this result, the restriction of strategy spaces to nonlinear pricing schedules
is without loss of generality. Then, once a strategy prole for other players has been conjectured,
the Revelation Principle is still available to determine best responses. In general, the need arises at
this point to extend the strategy spaces, so to include out-of-equilibrium menu oers. This would
happen if the agents choice within one principals menu aected her (potential) best option within
menus of other principals. This would yield messages that would not arise in a direct mechanism.
However, in this particular model one can invoke the Delegation Principle, without need to specify
out-of-equilibrium actions. The reason for this is that the agents choice among a rms products
doesnt alter what her choice would have been if she bought some other rms product instead.
4.2 Deterministic Contracts
It seems that the restriction to deterministic contract would still entail loss of generality. However,
consider a direct mechanism. Due to the exclusive dealing assumption, the agents true types
i
do
not aect her revelation choice of type
i
to seller i: In fact, conditional on contracting with principal
i; the type component
i
do not enter the agents utility function. Incidentally, this is another
5
This precise point is made more clearly in Epstein and Peters [4]:
6
Replace any indirect mechanism with the decentralized menus of payo-relevant contracting choices: obtain
equivalent equilibrium outcomes.
7
way of understanding why competition among principals only aects the participation decisions.
Therefore, screening through random contracts on the agents entire type would imply that
principals oer dierent lotteries to types (
i
;
i
). But then, given
i
; all types would simply choose
the lottery with the highest expected payo. The exclusive dealing assumption (A3) therefore makes
assumptions A1 and A2 without loss of generality
7
. In fact, if random contracts cannot improve
the principals options, partial revelation of type is sucient to design the optimal contract.
5 Duopoly Equilibrium
Let I = 2: Each seller i solves the following maximization problem:
max
q
i
();U
i
()
_

H

L
_

i
q
i
(
i
)
q
i
(
i
)
2
2
U
i
(
i
)
_
F
_

j
(
i
)
_
dF (
i
) (7)
s:t: U
i
(
i
) = U
j
_

j
(
i
)
_
s:t: IC and IR
Notice that the adverse selection problem between a single seller and the buyer is not dierent from
the traditional (Mussa Rosen [7]) case. The only dierences are given by the idiosyncratic tastes and
by competition among sellers. This should lead to expect that the shape of the optimal solution be
closer to the Mussa and Rosen [7] one than to that of Rochet and Stole [8] or other models of price
discrimination under imperfect competition. Note further that, in the absence of dierentiation
among buyers, competition among sellers would allow the agents rent to attain the level of the
entire (ecient) surplus in equilibrium. It is reasonable to conjecture that the equilibrium of
the idiosyncratic tastes model represents an intermediate solution between the monopoly and the
Bertrand (or perfect competition) cases.
Proposition 2 The symmetric equilibrium of the nonlinear pricing game with two rms is char-
acterized by the following rst-order conditions:
( q ()) F () f () + () = 0 (8)
F () f ()
_

q ()
2

U ()
q ()
_
f
2
() =
d()
d
(9)
(
H
) = 0 (10)
Proof. See the Appendix.
A few observations from these rst-order-conditions allow to draw insights on the shape of
the optimal taris at the symmetric equilibrium of this game. From the transversality condition
(10), the traditional no distortion at the top result remains true. In the Rochet and Stole [8]
and Armstrong and Vickers [1] models, a further no distortion at the bottom result emerges
7
Of course, the exclusive dealing clause represents a restriction. However, it allows to directly compare this models
results with those in the literature on screening (MR) and on discrete-choice models.
8
quite generally. This result does not necessarily extend to the idiosyncratic taste model. In the
equilibrium of this model the quality level q (
L
) that each seller associates to the buyer with lowest
valuation for her good is unconstrained (evaluate (8) at
L
). The reason for this indeterminacy is
that in equilibrium each rm will not serve such types with positive probability
8
.
This is arguably the main dierence between the equilibrium of this model and that of Rochet
and Stole. In RS, the random participation assumption induces sellers to serve a positive fraction
of all types
9
. Contrarily to this scenario, the symmetric equilibrium of the model with idiosyncratic
tastes reects the fact that competition will more likely attract away from a rm those customers
who like its products the least. The next (conjectured) result formalizes the dierence between the
two models.
Conjecture 1 In the duopoly symmetric equilibrium, in a neighborhood around
L
; distortions
persist, i:e: q () < :
Proof. From (8) (9), if q (
L
) =
L
then
_
(
L
) = 0 (dierentiate (8)). From (9) then
U (
L
) =
1
2
(
L
)
2
which is the value of the entire ecient surplus at
L
: This shouldnt have an
impact since in equilibrium no type
L
buys from the rm. However, if f (
L
) > 0 then since () is
continuous, the (near-)ecient quality provision will have to extend to a neighborhood of
L
. This
means that the agent obtains rents equal to the entire surplus over this neighborhood. Thus the
rm will make zero prots over a positive measure of customers. It could therefore make strictly
positive gains by introducing distortions, reducing rents accordingly and giving up market shares
in exchange for positive prots.
5.1 Analytical Solution with Uniform Distribution - an Example
Consider the duopoly model in which consumer types are independently, identically and uniformly
distributed on [
L
;
H
]
2
: The following result can be proved:
Proposition 3 When
H
=
5
2

L
; there is a solution with linear quality supply schedule in which
the lowest type receives zero quality (hence zero utility). This solution is characterized by
q () =
1
3
(5 2
H
)
U () =
5
6

2
3

H
+
2
15

2
H
8
This result can be generalized. At the symmetric duopoly equilibrium, (see f.o.c. (8)) each rm will meet a buyer
of type i with probability F (i).
9
The reason for this dierence is related to the fact that in both models the condition (L) = 0 is obtained as
part of the characterization of an equilibrium with U (L) > 0: In RS, this condition and the f.o.c.s imply q (L) = L
(eciency at the bottom). In the model with idiosyncratic taste, when (L) = 0; the f.o.c. at L is satised for any
value of q.
9
Proof. For the uniform distribution, the rst order conditions simplify to
( q ())

L
(
H

L
)
2
= () (11)
_
q ()
2
+
U ()
q ()

L
_
1
(
H

L
)
2
=
d()
d
(12)
q (
H
) =
H
(13)
Look for an equilibrium with a linear quality supply function q () = a + b: The transversality
condition (13) immediately imposes the restriction b =
H
(1 a) : The utility function is there-
fore U () =
H
a
H
+
1
2
a
2
+ c: Plugging in these functional forms and using the fact that
d
d
[LHS (11)] = LHS (12) one obtains the restriction on the support and the characterization of
q () and U () :
Let
L
= 1 and
H
=
5
2
; then the equilibrium quality schedule can be represented in the following
graph (the dashed lines indicate the monopoly and ecient quality levels).
2.5 2.25 2 1.75 1.5 1.25 1
2.5
2
1.5
1
0.5
0
Theta
q(Theta)
Theta
q(Theta)
Ecient, Duopoly and Monopoly quality provision.
The solution here obtained conrms the intuitive prediction of a quality provision path that lies
between the competitive (Bertrand) case and the MR monopoly solution. The result for the case
of a uniform distribution of types, this result can hopefully be generalized. It can be conjectured
that the solution involves shutdown of low types whenever
H
>
5
2

L
(in the MR case this happens
when
H
> 2
L
).
5.2 Numerical Simulations
Numerical solutions are available for the simple case in which rms oer fully-separating menus of
contracts that do not shut down any type : Using the IC constraint
dU
d
= q, conditions (8) (10)
10
can be reduced to the following boundary value problem:
_
U () = +
()
F () f ()
_
() =
_
_
F ()
_
_
f ()
2

()
2F ()

U () f ()
+
()
F()f()
_
_
_
_
f ()
(
L
) = (
H
) = 0
One diculty associated with solving this problem numerically is that the functions
_
_
U;
_

_
are
not well-dened at
L
(where F () = 0). The following graph describes another example using
the uniform distribution. In this simulation, parameter values were chosen so to highlight the
dierences between the fully competitive, monopoly, idiosyncratic taste and random participation
models:
4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 5
3
3.2
3.4
3.6
3.8
4
4.2
4.4
4.6
4.8
5
Monopoly, Duopoly and 1st Best Qualities
Theta
q
(
t
h
e
t
a
)
Types
i
Uniformly Distributed on [4; 5]
The dashed line represents the RS allocation (eciency at top and bottom) whereas the central
straight line is the idiosyncratic tastes quality provision. The top and bottom lines represent the
ecient and the monopoly qualities respectively.
Incidentally, it may be useful to consider cases with dierent distribution functions.
6 Extensions
The duopoly model can be extended to a more general setting, namely by introducing correlation
among types and by considering an arbitrary number of rms.
11
6.1 Correlated Types
Up to this point it has been assumed that the buyers types are identically and independently
distributed. The independence assumption does not seem particularly realistic. There may be
more than one reason to believe that a buyers marginal valuation of one brands product should
not dier substantially from her valuation of the same product of a dierent brand. This leads to
the conclusion that the marginal utilities from consuming products of dierent brands should be
positively correlated. To take this possibility into account, let types be distributed according to
the joint density:
f (
1
;
2
) = k (")
_
1 " (
1

2
)
2
_
= [1; 2]
2
This particular form chosen in this example can be viewed as a modied uniform distribution in
which the distance between the two type components
1
and
2
reduces the probability density
at type : The constant k (") just ensures that the density integrates to one over the support.
The intuitive prediction is that positive correlation should increase competition. The following
numerical example that for some parameter values this is indeed the case: quality provision (and
the agents rent) increase as compared to the independence case (the dashed line). Both allocations
lie in between the monopoly and the ecient levels of quality.
1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Monopoly, Oligopoly and 1st Best Qualities
Theta
q
(
t
h
e
t
a
)
Equilibrium with Correlated Types [" = 1;
L
= 1;
H
= 2]
It is important to point out that other simulations show radically dierent results. Simply changing
the support induces the following quality provision that is reminiscent of Rochet-Stole [8] (the other
12
lines are as in the previous graph).
4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 5
3
3.2
3.4
3.6
3.8
4
4.2
4.4
4.6
4.8
5
Monopoly, Oligopoly and 1st Best Qualities
Theta
q
(
t
h
e
t
a
)
Equilibrium with Correlated Types [" = 1;
L
= 4;
H
= 5]
This could be a promising way of establishing further conditions under which rms provide ecient
quality supply "at the bottom" of the distribution.
6.2 Oligopoly Equilibrium and Bargaining
The main qualitative features of the duopoly symmetric equilibrium can be shown (by way of
numerical simulations) to extend to the generic Irms case. When looking for a symmetric
equilibrium in the I sellers model, program (7) is virtually unchanged. The Hamiltonian can be
written as follows
H (q; U; ) =
_
q
q
2
2
U
_
[F (

(U))]
I1
f () + q
Computational diculties allow extension only to I = 2; 3; 4 ; but the numerical simulations
suggest that the shape of the optimal quality provision does not change. As the number of rms
increases, quality provision shifts towards the ecient levels and the agents rent increases. In this
setting, however, it does not seem possible to extend a result like the one in Conjecture 1. As a
matter of fact, the rst step in the conjectured proof would not be replicated if I _ 3: Intuitively,
ecient quality provision cannot be ruled out even for the lowest types as competition among rms
becomes more intense. The evolution of the quality provision for the uniform case and I = 2; 3; 4
13
can be seen from the following graph:
1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Monopoly, Oligopoly and 1st Best Qualities
Theta
q
(
t
h
e
t
a
)
Symmetric Equilibrium when I = 2; 3; 4
The formulation of the principals maximization program in the Irms case can also be interpreted
as a bargaining problem. Note that for each type
i
, the Hamiltonian is very similar to a Nash
product. In this ctitious bargaining game, the utility functions are given by the rms prot
margin on type
i
and an increasing function of type
i
s informational rent. The latter component
is weighted by the number of outside options (I 1) available to the buyer. As I increases, the Nash
bargaining solution to this problem must favor the buyer (higher utility, lower quality distortions).
The numerical simulations conrm this prediction.
7 Conclusions
This paper has attempted to characterize the symmetric equilibria of several pricing games when
the buyers valuation of the quality of dierent brands products may vary across the population.
The main nding is that this source of product dierentiation restores the MR quality distortions
that instead often disappear in random participation models. One exception is represented by the
case of correlated types.
The approach introduced in this paper adds realism to a simple model of competition with
nonlinear prices and is to be considered complementary to the random participation approach of
AV and RS. On the one hand, a "mixed model", combining the two approaches would be worthwhile
pursuing, although there is little scope for imagining that the results (in terms of quality provision)
would dier substantially from those already obtained in the literature. On the other hand, the
method developed in this paper is hopefully general and useful enough to study non-zero prot
14
equilibria of competitive nonlinear pricing games in a dynamic setting.
Appendix
Proof of Proposition 1
Show rst that prot functions are concave in p
i
: Then sign of
dp(I)
dI
is entirely determined by the
second partial cross-derivative of the prot function.
Collusive Case: Dierentiating the f.o.c. (3) wrt I at the optimal solution p
C
one obtains
that:
dp
C
dI
= I
2
_
F
I
(p) lnF
I
(p) 1
_
Now let F
I
(p) = x and note that (x lnx 1) _ 0 \x [0; 1] :
Competitive Case: The cross derivative of the prot function can be written and simplied
as follows:
@
2
@p@I
V =
1
I
2
_
1 F
I
(p)
_

@
@I
_
p
_
1
p
(I 1) f
2
() F
I2
() d
_

1
I
(lnF (p)) F
I
(p) pf (p) F
I1
(p) lnF (p) (14)
=
1
I
2
_
1 F
I
(p)
_

1
I
(lnF (p)) F
I
(p) pf (p) F
I1
(p) lnF (p)
p
_
1
p
_
f
2
() F
I2
() + (I 1) f
2
() F
I2
() lnF ()

d (15)
_ 1 + F
I

_
lnF
I
_
F
I
p
d
dp
F
I
lnF
I

_
1
p
_
d
dp
F
I
d
dp
lnF
I
_
1 + lnF
I
()
_
_
d
_ 1 + F
I

_
lnF
I
_
F
I
p
d
dp
F
I
lnF
I

_
1
p
dF
I
dp
d lnF
I
dp
d
_ 1 + F
I
2
_
lnF
I
_
F
I

_
1
p
dF
I
dp
d lnF
I
dp
d
=
_
1 F
I
+ 2
_
lnF
I
_
F
I
+
_
1
p
d lnF
I
dp
dF
I
dp
d
_
(16)
Now, if
d lnF
I
dp
_ 1 \p (17)
then
_
1
p
d lnF
I
dp
dF
I
dp
d _
_
1
p
dF
I
dp
d = 1 F
I
(p)
15
and (16) can be simplied to
2
_
1 F
I
+ F
I
lnF
I
_
(18)
Now let x = F
I
(p) and note that:
(1 x + xlnx) _ 0 \x [0; 1]
therefore (18) is negative everywhere. Finally, rewriting (17) ; one obtains the sucient condition
(5) :
f (p)
F (p)
_
1
I
Proof of Proposition 2
The Hamiltonian for this problem is:
H
i
(q
i
; U
i
;
i
;
i
) =
_

i
q
i

q
2
i
2
U
i
_
F
_

j
(U
i
)
_
f (
i
) +
i
q
i
Remember again that

j
(
i
) solves U
i
(
i
) U
j
_

j
(
i
)
_
= 0: Therefore, applying the Implicit
Function Theorem at each point
i
;
@

j
(
i
)
@U
i
=
1
dU
j
=d
j
=
1
q
j
_

j
_
the f.o.c.s can be written as follows:
H
q
: = (
i
q
i
) F
_

j
_
f (
i
) +
i
= 0
H
U
: = F
_

j
_
f (
i
)

i
q
i
q
2
i
=2 U
i
q
j
_

j
_ f
2
(
i
) =
d
i
d
i

i
(
H
) = 0
The symmetric equilibrium, is characterized by:
( q ()) F () f () + () = 0
F () f ()
_

q ()
2

U ()
q ()
_
f
2
() =
d()
d
(
H
) = 0
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16
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17