This paper studies capacity choice in a
quantity-setting and price-setting private duopoly with differentiated goods
wherein either of two firms has a price-raising effect on the price level of
the product of the opponent firm. In both quantity-setting and price-setting
competition, whether the price-raising effect of the product of one firm on the
price level of the other firm’s product is strong or weak strictly depends on
the differences between the quantities and capacity levels of both firms. More
precisely, in the quantity-setting competition, when the price-raising effect
is sufficiently strong, both firms choose under-capacity, whereas when such an
effect is sufficiently weak, both firms choose overcapacity. Furthermore, in
the price-setting competition, when the price-raising effect is sufficiently
strong, both firms choose over-capacity, whereas when such an effect is
sufficiently weak, both firms choose under-capacity. Therefore, the presence of
the price-raising effect as the unilateral externality strikingly changes the
difference between each firm’s quantity and capacity level in the contexts of
both the quantity-setting competition and the price competition in a private
duopoly with differentiated goods.
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