PRODUCT DIFFERENTIATION UNDER CONGESTION: HOTELLING WAS RIGHT

Authors

  • CHRISTIAN AHLIN,

    1. Ahlin: Department of Economics, Michigan State University, East Lansing, MI 48824. Phone 517-355-8306, Fax 517-432-1068, E-mail ahlinc@msu.edu
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  • PETER D. AHLIN

    1. Ahlin: Chatham Financial, Kennett Square, PA 19348, Phone 610-925-3120, Fax 610-925-3125, E-mail pahlin@chathamfinancial.com
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    • We thank especially Herve Moulin for initiating a preliminary version of this project with P. D. Ahlin. We also thank two referees and the editor Tim Brennan along with Rick Bond, Andy Daughety, Arijit Mukherjee, Martin Osborne, Carolyn Pitchik, Jennifer Reinganum, Oz Shy, and various conference participants for helpful comments. All errors are our own.


Abstract

We introduce negative network externalities—“congestion costs”—into H. Hotelling's (1929) model of spatial competition with linear transportation costs. For any firm locations on opposite sides of the midpoint, a pure strategy price equilibrium exists and is unique if congestion costs are strong enough relative to transportation costs. We analyze product differentiation and find that Hotelling's Principle of Minimum Differentiation comes closer to holding in the presence of congestion costs. The greater are congestion costs, the less differentiated products can be in (locationally symmetric) equilibrium. In fact, minimum differentiation comes arbitrarily close to holding depending on the magnitude of these costs relative to transportation costs. Intuitively, greater congestion effects stabilize competition at closer quarters, eliminating aggressive pricing equilibria. Thus, negative network externalities can play a significant role in product differentiation. (JEL D21, L15, R12)

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