Quality and Quantity Competition

Non-price competition is observed in many oligopolistic industries, and raises important policy questions. For example, it is often thought that there is an excess of it in industries such as the airlines when they successfully enforce collusion over price. Another instance is the recent discussion on whether legal and medical professions should be allowed to advertise. While such issues have a long history of general debate in industrial economics, there have been very few attempts to pin them down by constructing precise models. Spence (1975) and Sheshinski (1976) have recently analysed quality and quantity choices of a monopolist, and Spence (1977) has studied the case of Chamberlinian monopolistic competition, in each case comparing the market equilibrium and the social optimum. In monopoly both variables are collusively set, while in the Chamberlinian case they are both competitively set. However, the most interesting aspect of many practical issues is the interaction between collusion in one dimension and competition in the other. The possibility of enforcing a collusive decision generally differs with respect to different choice variables, and competitive decisions react to collusion elsewhere. The various conceivable equilibria should be compared with each other as well as with the social optimum. That is the aim of this paper. When analysing the problem, we must also consider the total number of products in the industry. If this is competitively set, i.e. if there is free entry, then any power to control the other variables might as well not be used, since entry will eliminate profit in any case. If entry can be controlled, it becomes important to specify the objective. Where one member is one product, as in the professions, it seems sensible to maximize profit per product. But where there is a fixed number of members with a variable number of products per member, as with a fixed number of airlines setting flight schedules, total profit becomes the maximand. The outcome turns out to depend crucially on this distinction. If the collusive objective is profit per product, it is found that control of entry is tantamount to total control. Once entry has been set at its collusive optimum level, competitive individuals will make quantity and quality choices that are the same as the collusive optima. This is essentially an " envelope " property. On the other hand, if the collusive goal is total profit, equilibria for different combinations of collusion and competition differ. It is found that quality competition is used in an overcompensating manner if quantity competition is suppressed, but the welfare effect of this is ambiguous. In some parameter ranges it is found that welfare is lowered by enforcement of competition in only one dimension; these are specific occurrences of the general second-best possibility. Quality choice and advertising are two aspects of non-price competition. In my model they affect demand in the same way and therefore have identical positive comparative static effects. But advertising affects the standard of welfare judgement and therefore needs a different treatment of its normative effects; see Dixit and Norman (1978). This distinction should be borne in mind when applying the results that follow.