Production versus safety in a risky competitive industry

Abstract

Each of two firms has a resource that can be converted into safety versus productive investment in the first stage, with Bertrand competition on price in the second stage of a two-stage game. The firms produce differentiated products in a risky environment. If risks are negligible, investing more in safety decreases the price, and producing more increases the price. The results depend on whether risks get reduced concavely or convexly. With concave (convex) risk reduction, higher safety investment by the competitor causes higher (lower) own safety investment. With concave (convex) risk reduction, lower firm loyalty by consumers implies lower (higher) safety investment, higher product substitutability implies higher (lower) safety investment, and more adverse implications of the competitor’s productive investment on the demand intercept of the firm implies lower (higher) safety investment. When each firm independently maximises profit in a Nash equilibrium, safety investment is lower than when a social planner maximises social welfare and when maximising joint industry profits. The impact of the income, substitution, and interdependence effects on safety investment and price is finally analysed.