Welfare in a differentiated oligopoly with free entry: a cautionary note

Abstract

We model a free-entry equilibrium in a differentiated oligopoly where firms compete either in prices or in quantities. We show that the latter setting allows for at least as many firms to survive as the former. Thus, the entry process can jeopardize the common view that price competition is always welfare improving. We show that quantity competition can lead to a larger social welfare whenever different numbers of firms operate under the two regimes. In particular, the higher product differentiation, the wider the paramenter region wherein quantity competition dominates price competition from a social welfare perspective.