Reciprocity, Inequity Aversion, and Oligopolistic Competition, †

This paper extends the Cournot and Bertrand models of strategic interaction\nbetween firms by assuming that managers are not only profit maximizers,\nbut also have preferences for reciprocity or are averse to inequity. A reciprocal\nmanager responds to unkind behavior of rivals with unkind actions, while at the\nsame time, it responds to kind behavior of rivals with kind actions. An inequity\naverse manager likes to reduce the difference between own profits and the rivals’\nprofits. The paper finds that if firms with reciprocal managers compete à\nla Cournot, then they may be able to sustain “collusive” outcomes under a constructive\nreciprocity equilibrium. By contrast, Stackelberg warfare may emerge\nunder a destructive reciprocity equilibrium. If there is Cournot competition between\nfirms and their managers are averse to advantageous (disadvantageous)\ninequity, then firms are better (worse) off than if managers only care about maximizing\nprofits. If firms compete à la Bertrand, then only under very restrictive\nconditions will managers’ preferences for reciprocity or inequity aversion have\nan impact on equilibrium outcomes.