Price and Non-Price Competition

Abstract

When a uniform price is imposed upon, or agreed to by, an industry, some or all of the other terms of sale are left unregulated. The setting of taximeter rates still allows competition in the quality of the automobile. The fixing of commission rates by the New York Stock Exchange still allows brokerage houses to compete in services such as providing investment information. If additional firms may enter such a price-regulated field at no cost disadvantage, profits resulting from the price regulation will be eliminated in long-run equilibrium. But in the absence of free entry-and both the medallions required of taxis and the seats of New York Stock Exchange members are fixed in number-the question arises: Will any monopoly profit achieved by suppressing price competition be eliminated by nonprice competition? We may emphasize that a symmetrical question arises if the firms are required to sell the same product (that is, have the same non-price variable) but are allowed to compete freely in prices. For example, let every seller of gasoline provide the identical product. Will free price competition eliminate any monopoly profits arising from agreement not to compete in the quality of gasoline? Economists generally attribute much more efficacy to price than to non-price competition without giving any clear explanation of the asymmetry of the two kinds of competition. Let us take advertising as the prototype of non-price variables. A previously competitive industry may form a cartel and (1) fix advertising jointly and allow competition in price or (2) fix price jointly and allow competition in advertising. We examine the two cases in turn. Let each firm be operating, under competition, at output Q0 and price P0 (Fig. 1). Upon colluding on advertising, marginal costs-which include the costs of advertising-are reduced at every output for each firm.1 The 1 Economists who find it uncomfortable to discuss advertising in a competitive industry can substitute another non-price variable (such as durability of product, investment advice, or warranties of free repairs) with only terminological effects.