Product Design in a Hedonically Differentiated Duopoly

Abstract

Abstract Using a reduced version of the generalized hedonic linear (GHL) model developed by Pellegrino (2025. “Product Differentiation and Oligopoly: A Network Approach.” The American Economic Review 115 (4): 1170–225), we study the strategic design of products in a multidimensional characteristics space. We construct a simple two stage duopoly game in which firms first choose the design of their product and then set their output. We show that at the unique subgame perfect Nash equilibrium both firms choose the unique product design perfectly aligned with the consumer’s ideal bundle of characteristics. We characterize how this outcome emerges through an adjustment dynamics in which product design becomes the key strategic instrument for gaining a competitive advantage in the quantity subgame. We refer to this process as the undercutting mechanism.