| The objective of this dissertation is to analyze collusive behavior in market which is characterized by horizontal product differentiation. In a differentiated products industry, firms offering similar products have a strong incentive to coordinate their pricing decisions in order to avoid severe price competition. However, the temptation to defect from the collusive agreement is also quite strong if their is strong substitutability between products. Defection is tempting because a slight reduction in price will result in a significant increase in firm demand. Consequently, the degree of product differentiation is of great importance on sustaining a collusive agreement.; The spatial competition model of Hotelling (Economic Journal, 1929) is extended to represent a horizontally differentiated products market in a supergame setting. The first step is to investigate the relationship between the degree of product differentiation and the ability of firms to collude. In achieving this end, we focus our attention on the price game while treating the product locations as fixed. Our findings suggest that collusion is more difficult to sustain the smaller the degree of product differentiation.; In step 2, we allow firms to make location choices in the beginning of the game (stage 1) followed by the infinite horizon price game (stage 2). In this setting, we find that firms with a high valuation of future profits differentiate their products only moderately so as to capture local monopoly power in each segmented market. This result has significant welfare implications in that the collusive duopoly may provide a socially optimal product variety by reducing the need to excessively differentiate.; Finally, we extend the model to allow for product relocation by firms. A set of (feedback) equilibrium decision rules is derived to specify for each firm which product to select and what price to charge each period in the absence of collusion. Characterizing the punishment path by the set of equilibrium decision rule derived in this manner, we show that the collusive outcome is sustained as a closed-loop subgame perfect equilibrium if firms sufficiently value future profits. Furthermore, it is found that flexible product relocation makes collusion more difficult because it reduces the severity of punishments. |
