Product Differentiation, Uncertainty and the Stability of Collusion

Michael Raith, University of Rochester

Abstract

The conventional view that product heterogeneity limits the scope for collusion among oligopolists has been challenged in recent theoretical work. This paper provides an argument in support of the conventional view by emphasising the role of uncertainty. I introduce the idea that, with stochastic demand, an increase in the heterogeneity of products leads to a decrease in the correlation of the firms’ demand shocks. With imperfect monitoring, this makes collusion more difficult to sustain, as discriminating between random demand shocks and marginal deviations from the cartel strategy becomes more difficult. These effects are illustrated within a Hotelling-type duopoly model.