A Study On The Vertical Differentiation Strategy Under Demand Uncertainty

One of the most important knowledge in industrial organization is market structure, among which product differentiation is an important thing. After Hotelling first proposed this theory since1929, this knowledge has been studied and researched many times. Many scholars have been aware that the theory of product differentiation became more and more important in modern market during their research. The application of the theory among oligopoly models is very often, especially in the three classical models named Cournot, Bertrand and Stackelberg. This theory plays important role in modern firm competition. Many papers about the theory assumed that consumers are uniformly distributed on the section [0,1], or market demand is certain. With this kind of assumption, two firms competed with the certain demand function, and resulted in the differentiation plan. All of the papers have a good description about product differentiation, however, they all neglect one important thing, the market is changing all the time. When there is a fluctuation on the demand, what should the oligopoly firms do to deal with the situation, and what kind of product differentiation should they choose?The assumption in this paper is that there is a little fluctuation∈on the demand, and two firms will compete in the following kinds of situations. In the chapter3, we will discuss the Bertrand model and Stackelberg model, and the follower should pay for the entry in chapter4. Also we research the effect of the consumer preference on the entry behavior.The market fluctuation came from the following situation:when there is a new firm in the market, the equilibrium of the market may be broken, for example, the emergence of the E-business. Then the convenience of the consumption, the diversity of the product service may have an influence on the product demand function, result in the fluctuation on the aggregate demand of the market, which may not exist in the former situation. The firms in the market produce different quality products, accordingly, differ in marginal cost. Then in the second stage, the firms will compete in price, and quality in the first stage. We will gain the quality choices, prices and profits with backwards induction, and analyze the relationship between equilibrium strategy and market fluctuation.The results indicate that:in the three different competition models, the fluctuation of the demand will lead to the same change of the degree of product differentiation, also the change of the firms’profits and prices. In the cases of the symmetry competition, the firm that produces the low quality product will force out the high quality firm. The leader firm in the market will gain more profit than the follower in the Stackelberg competition model, and the profit difference will change with the market fluctuation, also the vertical differentiation. Now with the payment of the follower, it’s a different case. When the payment is very low, the follower will enter the market on its own decision regardless of the leader’s quality choice, on the contrary, when the payment is high, only with the leader’s quality is among a special region, the entry may happen. After the entry, I analyze the influence of the market fluctuation on the differentiation with the Stackelberg model, with the result that the fluctuation will affect the differentiation choices. At last, I research the influence of the fluctuation on the monopoly firm’s decision on the making of entry barrier. In the chapter5, I analyze the results of these kinds of situation. Chapter6is the complimentary close.