Product Differentiation in a Regulated Market: A Welfare Analysis

This article analyses both a circular and a linear market where consumers are distributed along the whole space, whilst firms are located in a region restricted by the regulator. We consider a three stage game in which in the first stage the regulator chooses the size of the space where firms will be located (the commercial area), in the second stage firms choose locations and in the third stage they compete in prices.

We find that with this type of market configuration there exists price equilibrium for every possible firms’ location independently of space considered under quadratic transportation costs. We also derive that the optimal size of the commercial area will depend on the welfare function of the regulator and, in particular, that once a regulator bias is considered, máximum differentiation, minimum differentiation or intermediate cases may be obtained.

Keywords: spatial competition, circular model, linear model, convex transportation costs, regulation, sequential equilibrium, social welfare.