Abstract. I analyze a duopoly that competes first in product characteristics and then in prices. I show that when there exist consumers that are loyal to specific brands with no regard for product characteristics, the second-stage price game doesn’t have a pure-strategy equilibrium or symmetric mixed-strategy equilibrium and the firms choose to maximize their product differentiation in the first stage, contrary to what is usually assumed in the price dispersion literature.

Keywords: pricing; product differentiation; price competition.