It pays to be different: Endogenous heterogeneity of firms in an oligopoly

Abstract

Heterogeneous firms can be supported by familiar conditions of technology and demand in a two-stage duopoly game. Firms choose technologies simultaneously in stage I from a continuous technology set. In stage II, once technological commitments have been made, firms choose quantities and the equilibrium price is determined. If the technology set is insufficiently convex, firms choose only the extreme production technologies. In some cases they choose the same technology; in others they choose different technologies. When compared to socially-optimal industry structures, equilibria tend to have too little heterogeneity. Uncertainty about demand or costs favors the emergence of heterogeneous firms.