Nonlinear Pricing in Oligopoly: How Brand Preferences Shape Market Outcomes

ABSTRACT We study oligopolistic competition by firms practicing second‐degree price discrimination. In line with the literature on demand estimation, our theory allows consumers' propensity to switch brands to vary with tastes for product quality. If low‐type consumers are sufficiently more (respectively, less) prone to switch brands than are high types, (i) quality provision is inefficiently low at the bottom (respectively, high at the top) of the product line, and (ii) informational rents are positive (respectively, negative) for high types and negative (respectively, positive) for low types. Interestingly, we show that an increase in the number of competing firms may decrease welfare (by tightening incentive constraints), so much so that monopoly may be welfare superior to oligopoly. Pure‐strategy equilibria fail to exist, resulting in price‐quality dispersion across firms, whenever the propensity to switch brands is sufficiently different across consumers types.