On the Existence and Social Optimality of Equilibria in a Hotelling Game with Uncertain Demand and Linear-Quadratic Costs

Abstract

This paper examines a variant of the Hotelling two-stage mill-pricing duopoly game with “linear-quadratic” transport costs and the uniform customer distribution subject to a random shock. The demand is equally likely to be found anywhere in a fixed interval of feasible product characteristics, with the ex-post differentiation of tastes parametrized to reflect the degree of uncertainty. It turns out that, for uncertainty big enough, the presence of a linear component in the cost function no longer rules out an analytical solution to the game, which is a common problem in spatial competition models. In particular, a subgame-perfect equilibrium is shown to exist in which the firms’ locations approach the socially efficient ones as uncertainty further increases, regardless of the curvature of the cost function. When the demand uncertainty reaches maximum, mill-pricing is equivalent to spatial price discrimination under the most general conditions.