Portuguese Economic Journal

, Volume 10, Issue 3, pp 165–188 | Cite as

Costly horizontal differentiation

Original Article


We study the effect of quadratic differentiation costs in the Hotelling model of endogenous product differentiation. The equilibrium location choices are found to depend on the magnitude of the differentiation costs (relatively to the transportation costs supported by consumers). When the differentiation costs are low, there is maximum differentiation. When they are high, there is partial differentiation, with a degree of differentiation that decreases with the differentiation costs. In any case, the socially optimal degree of differentiation is always lower than the equilibrium level. We also study the case of collusion between firms. If firms can combine locations but not prices, they locate asymmetrically when differentiation costs are high and choose maximum differentiation when they are low. When collusion extends to price setting, there is partial differentiation.


Costly product differentiation Spatial competition Collusion Hotelling model 

JEL Classification

D43 L13 R32 



We thank Frago Kourandi, Odd Rune Straume (Editor) and three anonymous referees for useful comments and suggestions which allowed us to improve this paper. João Correia-da-Silva (joao@fep.up.pt) acknowledges support from Fundação para a Ciência e Tecnologia and FEDER (research grant PTDC/EGE-ECO/108331/2008) and from CEF.UP. Joana Pinho (jpinho@fep.up.pt) acknowledges support from Fundação para a Ciência e Tecnologia (Ph.D. scholarship).


  1. Aiura H, Sato Y (2008) Welfare properties of spatial competition with location-dependent costs. Reg Sci Urban Econ 38:32–48CrossRefGoogle Scholar
  2. Brekke KR, Straume OR (2004) Bilateral monopolies and location choice. Reg Sci Urban Econ 34:275–288CrossRefGoogle Scholar
  3. Chang M-H (1991) The effects of product differentiation on collusive pricing. Int J Ind Organ 9:453–469CrossRefGoogle Scholar
  4. Cramton PC, Palfrey TR (1990) Cartel enforcement with uncertainty about costs. Int Econ Rev 31:17–47CrossRefGoogle Scholar
  5. D’Aspremont C, Gabszewicz JJ, Thisse J-F (1979) On Hotelling’s ‘Stability in competition’. Econometrica 47:1145–1150CrossRefGoogle Scholar
  6. Eaton BC, Schmitt N (1994) Flexible manufacturing and market structure. Am Econ Rev 84:875–888Google Scholar
  7. Friedman JW, Thisse J-F (1993) Partial collusion fosters minimum product differentiation. Rand J Econ 24:631–645CrossRefGoogle Scholar
  8. Gupta B, Kats A, Pal D (1994) Upstream monopoly, downstream competition and spatial price discrimination. Reg Sci Urban Econ 24:529–542CrossRefGoogle Scholar
  9. Häckner J (1995) Endogenous product design in an infinitely repeated game. Int J Ind Organ 13:277–299CrossRefGoogle Scholar
  10. Hotelling H (1929) Stability in competition. Econ J 39:41–57CrossRefGoogle Scholar
  11. Jehiel P (1992) Product differentiation and price collusion. Int J Ind Organ 10(4):633–641CrossRefGoogle Scholar
  12. Kihlstrom R, Vives X (1992) Collusion by asymmetrically informed firms. J Econ Manage Strategy 1(2):371–396CrossRefGoogle Scholar
  13. Kourandi F, Vettas N (2010) Endogenous spatial differentiation with vertical contracting. CEPR Discussion Papers, 7948Google Scholar
  14. Lambertini L (1997a) Optimal fiscal regime in a spatial duopoly. J Urban Econ 41:407–420CrossRefGoogle Scholar
  15. Lambertini L (1997b) Unicity of the equilibrium on the unconstrained hotelling model. Reg Sci Urban Econ 27:785–798CrossRefGoogle Scholar
  16. Matsushima N (2004) Technology of upstream firms and equilibrium product differentiation. Int J Ind Organ 22:1091–1114CrossRefGoogle Scholar
  17. Meza S, Tombak M (2009) Endogenous location leadership. Int J Ind Organ 27(6):687–707CrossRefGoogle Scholar
  18. Miklós-Thal J (2008) Delivered pricing and the impact of spatial differentiation on cartel stability. Int J Ind Organ 26(6):1365–1380CrossRefGoogle Scholar
  19. Tabuchi T, Thisse J-F (1995) Asymmetric equilibria in spatial competition. Int J Ind Organ 13:213–227CrossRefGoogle Scholar
  20. Ziss S (1993) Entry deterrence, cost advantage and horizontal product differentiation. Reg Sci Urban Econ 23(5):523–543CrossRefGoogle Scholar

Copyright information

© Springer-Verlag 2010

Authors and Affiliations

  1. 1.CEF.UPUniversidade do PortoPortoPortugal
  2. 2.Faculdade de EconomiaUniversidade do PortoPortoPortugal

Personalised recommendations