COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1277

Entry and Vertical Differentiation

Dirk Bergemann and Juuso Välimäki

October 2000

This paper analyzes the entry of new products into vertically differentiated markets where an entrant and an incumbent compete in quantities. The value of the new product is initially uncertain and new information is generated through purchases in the market. We derive the (unique) Markov perfect equilibrium of the infinite horizon game under the strong long run average payoff criterion.

The qualitative features of the optimal entry strategy are shown to depend exclusively on the relative ranking of established and new products based on current beliefs. Superior products are launched relatively slowly and at high initial prices whereas substitutes for existing products are launched aggressively at low initial prices.

The robustness of these results with respect to different model specifications is discussed.

JEL Classification: C72, C73, D43, D83

Keywords: Entry, Duopoly, Quantity Competition, Vertical Differentiation, Bayesian Learning, Markov Perfect Equilibrium, Experimentation, Experience Goods