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Dynamic Price Competition and Stackelberg Warfare

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  • Byoung Jun
  • Xavier Vives

Abstract

We show in a differential game of a differentiated product duopoly model of price competition with costly production adjustment that when firms are symmetric the leadership attempt by each firm turns into Stackelberg price warfare yielding a (Markov perfect) steady state outcome more competitive than static Bertrand competition. The static strategic complementarity in the price game is turned into intertemporal strategic substitutability. The analysis of the paper allows for a comparison of steady states of open-loop and locally stable Markov perfect equilibria in a general dynamic duopoly model with costs of adjustment and characterizes completely strategic incentives in its linear-quadratic specification. The result is that when production (price) is costly to adjust there is intertemporal strategic substitutability (complementarity) and the steady state of the Markov perfect equilibrium is more (less) competitive than the steady state of the open-loop equilibrium, which coincides with the static outcome.

Suggested Citation

  • Byoung Jun & Xavier Vives, 1998. "Dynamic Price Competition and Stackelberg Warfare," Harvard Institute of Economic Research Working Papers 1838, Harvard - Institute of Economic Research.
    • Handle: RePEc:fth:harver:1838
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