We study a duopoly model where consumers are heterogeneous with respect to their willingness to pay for two product characteristics and marginal costs are increasing with the quality level chosen on each attribute. We show that while firms seek to manage competition through product positioning, their differentiation strategies critically depend on how costly it is to provide higher quality. When the cost of providing quality is not too high, firms use only one attribute to differentiate their products: they maximally differentiate on one dimension and minimally differentiate on the other dimension (a Max-Min equilibrium). Furthermore, they always differentiate along the dimension with the greater attribute range. As for the dimension with the smaller range and along which they agglomerate, both firms either choose the highest quality level or the lowest quality level possible, depending on whether the marginal costs of quality provision are low or intermediate, respectively. However, for larger quality provision costs, firms exploit both dimensions to differentiate their products. In particular, we characterize a maximal differentiation equilibrium in which one firm chooses the highest quality level on both attributes, while its rival offers the lowest quality level on both attributes (a Max-Max equilibrium). We discuss the managerial implications of our findings and explain how they enrich and qualify previous results reported in the literature on two-dimensional differentiation models.

There are few industries in modern market economies that do not manufacture differentiated products. This book provides a systematic explanation and analysis of the widespread prevalence of this important category of products. The authors concentrate on models in which product selection is endogenous. In the first four chapters they consider models that try to predict the level of product differentiation that would emerge in situations of market equilibrium. These market equilibria with differentiated products are characterised and then compared with social welfare optima. Particular attention is paid to the distinction between horizontal and vertical differentiation as well as to the related issues of product quality and durability. This book brings together the most important theoretical contributions to these topics in a succinct and coherent manner. One of its major strengths is the way in which it carefully sets out the basic intuition behind the formal results. It will be useful to advanced undergraduate and graduate students taking courses in industrial economics and microeconomic theory.

We analyze price and quality competition in a vertically differentiated duopoly in which consumers have a preference for variety. The variety-seeking preferences are a consequence of diminishing marginal utility for repeated consumption experiences of the same product. We find that variety-seeking preferences can either soften or intensify price competition, depending on the range of feasible qualities and the strength of consumer preference for variety. When the range of feasible qualities is small enough, prices are higher than would be obtained in the absence of variety seeking - leading to higher profits - and competing firms choose to minimally differentiate themselves from each other. On the other hand, if qualities are exogenously set to be different enough from each other then stronger preferences for variety are associated with moreintense price competition and lower profits.

It is well established in vertical product differentiation models that the high-quality firm reaps a larger profit in a two-stage quality-price game as long as the cost of quality improvement is zero or is borne as fixed cost in the first stage quality choice. This note shows that the high-quality advantage may fail to hold if there is variable cost of production that is dependent on quality.

After the initial breakthrough in the research phase of R&D a new product undergoes a process of change, improvement and adaptation to market conditions. We model the strategic behavior of firms in this development phase of R&D. We emphasize that a key dimension to this competition is the innovations that lead to product differentiation and quality improvement. In a duopoly model with a single adoption choice, we derive endogeneously the level and diversity of product innovations. We demonstrate the existence of equilibria in which one firm enters early with a low quality product while the other continues to develop the technology and eventually markets a high quality good. In such an equilibrium, no monopoly rent is dissipated and the later innovator makes more profits. Incumbent firms may well be the early innovators, contrary to the predictions of the hypothesis.