Chapter 22: Hotelling’s Model of Spatial Competition
Nisvan Erkal Seventy years ago, Harold Hotelling’s paper ‘Stability in Competition’ was published in the Economic Journal. It represents a seminal contribution to the theory of spatial competition. Providing an appealing framework to address the nature of competition in characteristics as well as geographical space, it has resulted in a vast amount of academic research. In fact, Hotelling’s line has become the single most popular model of horizontal differentiation in economics. Product selection is a critical decision for firms. Firms differentiate their products to decrease the competition between them and to have some market power. Following Lancaster (1979, ch. 2), it is common to distinguish between two cases of product differentiation. Models of product selection typically involve either vertical or horizontal product differentiation. Two products are horizontally differentiated when there is no ranking among consumers based on their willingness to pay for the products. Both products have a positive demand whenever they are offered at the same price and heterogeneity in preferences over characteristics explains why both products are present in the market. Two products are vertically differentiated if one product captures the whole demand when both are supplied at the same price. Hence, all consumers have the same ranking between the different products offered at the same price. In the standard Hotelling model of horizontal differentiation, consumers are defined by their ideal products (locations) in characteristics (geographical) space and by a disutility for not consuming their ideal product. It was Hotelling himself who emphasized the similarity between characteristics and...
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