Partial Cooperation, Spatial Agglomeration, and Heterogeneity of Firms in a Horizontal and Vertical Differentiation

Abstract

This paper constructs a horizontally and vertically differentiated product model in a repeated, collusive pricing game. Based upon different profit-sharing rules, it examines the interacting effects of (vertical) quality distortion and cost difference on (horizontal) market competition. It shows that the asymmetry between marginal cost and perceived quality matters for the emergence of agglomeration. If the magnitude of cost differentials between firms is equal to the magnitude of quality difference, minimal horizontal differentiation emerges in each period regardless of the order of moves and profit-sharing rules. If the magnitudes of cost and quality differences differ, non-minimal horizontal differentiation emerges in each period in a simultaneous-move game. In a sequential-move game, the second-mover advantage exists if the second mover’s strong suit dominates the first mover’s one. Spatial agglomeration/minimal differentiation emerges when the second mover chooses the same location as the first mover under profit maximization. The heterogeneity creates a conflict of interest between firms. Hence, agglomeration appears with the heterogeneity of firms under certain conditions in equilibrium. JEL classification: C70, D43, L11, R12