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Editor: D. Daniel Sokol
University of Florida
Levin College of Law

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Friday, February 25, 2011

Product differentiation decisions under ambiguous consumer demand and pessimistic expectations

Posted by D. Daniel Sokol

Michal Król (Economics, The University of Manchester) addresses Product differentiation decisions under ambiguous consumer demand and pessimistic expectations.

ABSTRACT: This paper examines the e¤ects of violating the common prior assumption embedded in the Product differentiation and location deci- sions under demand uncertainty model by Meagher and Zauner (Journal of Economic Theory [2004]). In particular, a situation is discussed in which the firms do not know the exact distribution of the location and price elasticity of consumer demand, but resolve the resulting ambiguity using the Arrow and Hurwicz -maxmin criterion When the firms are sufficiently pessimistic ( is high enough), the results are in contrast with the existing literature. In particular, an increase of demand location uncertainty decreases the equilibrium product differentiation, as well as the resulting second-stage equilibrium prices and profits for any realisation of consumer demand, although the e¤ect is dampened by a possibility of higher price elasticity of demand. Furthermore, pessimism could serve as a form of strategic deterrence, because any …rm that can commit itself to a more pes- simistic approach increases its equilibrium share of the market and becomes better o¤ at the competitor’s expense. However, this generates a Prisoner's Dilemma situation, since both firms lose when they both become more pes-simistic, suggesting that the presence of ambiguity can make the market more competitive.

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