When does variety increase with quality?

Basov, Suren and Danilkina, Svetlana and Prentice, David (2009): When does variety increase with quality?

Abstract

Casual empiricism suggests higher quality is associated with greater variety. However, recent theoretical and empirical research has either not considered this link, or has been unable to establish unambiguous predictions about the relationship between quality and variety. In this paper we develop a simple model, which predicts that for low qualities variety should be positively correlated with quality and we establish conditions under which variety will either increase or decrease with quality at higher quality levels. The producer uses variety to increase the profitability of price discrimination across different qualities, by increasing the likelihood consumers choose high price products among products yielding the same utility. We show that the number of varieties offered by the monopolist is greater than the social optimum. The predictions of the model are supported by an empirical analysis of the market for cars. A wide range of car manufacturers are found to offer a hump-shaped distribution of varieties.

• Item Type: MPRA Paper
• Language: English
• Keywords: Price discrimination; product variety; bounded rationality; cars.
• Subjects: L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure ; Size Distribution of Firms; L - Industrial Organization > L6 - Industry Studies: Manufacturing > L62 - Automobiles ; Other Transportation Equipment ; Related Parts and Equipment; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality ; Standardization and Compatibility; D - Microeconomics > D4 - Market Structure, Pricing, and Design

References

Anderson, S.P., dePalma, A. and Thisse, J.-F. Discrete choice theory of product differentiation, MIT Press, Cambridge, MA, (1992).

Anderson S. P., Goeree, J. K. and Holt, C. A. Noisy directional learning and the logit equilibrium, Scandinavian Journal of Economics, 106(3), 581-602, (2004).

Ansari, A., Economides, N. and Steckel, J. The max-min-min principal of product differentiation, Journal of Regional Science, 38, 207-230, (1998).

Basov, S. Incentives for boundedly rational agents, Topics in Theoretical Economics, 3, Article 2, 1-14, (2003).

Basov, S. Multidimensional Screening, Series: Studies in Economic Theory, volume 22, Springer-Verlag: Berlin, (2005).

Basov, S. The mechanics of choice, In: Progress in Economics Research, v.10, A. Tavidze (ed.), 55-64, Nova Science Publishers, NY, (2006).

Basov, S. Monopolistic screening with boundedly rational consumers, The Economic Record, 85(S1), S29-S33, (2009).

Berry, S., J. Levinsohn and A. Pakes. Automobile Prices in Market Equilibrium. Econometrica, 63 (4), 841 - 890, (1995).

Bush, R. and Mosteller, F. Stochastic models for learning. Wiley, New York, (1955).

Champsaur, P. and Rochet, J.-C. Multiproduct duopolists, Econometrica, 57(3), 533-557, (1989).

Cheng, M.-Y. and Hall, P. Calibrating the excess mass and dip tests of modality, Journal of the Royal Statistical Society, Series B, 60, 579-589.

Draganska, M. and Jain, D. C. Product-Line length as a competitive tool, Journal of Economics and Management Strategy, 14, 1-28, (2005).

Draganska, M. and Jain, D. C. Consumer Preferences and Product-Line Pricing Strategies: An Empirical Analysis, Marketing Science, 25, 164-174,(2005a).

Draganska, M., M. Mazzeo and K. Seim, Beyond plain vanilla: Modeling joint product assortment and pricing decisions, Quantitative Marketing and Economics, 7, 105-146, (2009).

Falmange, J.-C. A Representation Theorem for Finite Random Scale Systems, Journal of Mathematical Psychology, 18, 52-72, (1978).

Foster, D. and Young, P. Stochastic evolutionary game theory. Theoretical Population Biology, 38, 219-232, (1990).

Friedman, D. The evolutionary game model of financial markets, Quantitative Finance, 1, 177-185, (2000).

Friedman, D. and Yellin, J. Evolving landscapes for population games, University of California Santa Cruz, mimeo, (1997).

Fudenberg, D. and Harris, C. Evolutionary dynamics with aggregate shocks. Journal of Economic Theory, 57, 420-41, (1992).

Fudenberg, D. and Levine, D. K., The theory of learning in games, Cambridge, MA, MIT Press, (1998).

Glass’s Guide. Black and White Data Book, Glass’s Guide, Melbourne, (1998).

Henderson, D. J., Parmeter C. J., and R. R. Russell. Modes, weighted modes, and calibrated modes: evidence of clustering using modality tests. Journal of Applied Econometrics, 23, 607-638, (2008).

Hofbauer, J. and Sandholm, W. H. On the global convergence of stochastic fictitious play, Econometrica, 70, 2265-2294, (2002).

Kandori, M., Mailath, G. and Rob, R. Learning, mutation and long run equilibria in games. Econometrica, 61, 29-56, (1993).

Lancaster, K. The economics of product variety: A survey, Marketing Science, 9, 189-206, (1990).

Luce R. D. Individual choice behavior, Wiley, New York, (1959).

Machina, M.J. Stochastic choice functions generated from deterministic preferences over lotteries, The Economic Journal, 95, 575-594, (1985).

Mas-Colell, A., Whinston, M. D. and Green, J. R. Microeconomic theory, Oxford University Press, (1995).

Mussa, M. and S. Rosen. Monopoly and Product Quality, Journal of Economic Theory, 18, 310-317, (1978).

Neven, D. and Thisse, J. On quality and variety in competition, in Gabszewicz, J., Richard, J. and Wolsley, J., (eds): Economic Decision-Making: Games, Econometrics, and Optimization, Elsevier, Amsterdam, (1990).

Prentice, D. and Yin, X. Constructing a quality-adjusted price index for a heterogeneous oligopoly, The Manchester School, 72, 423-442, (2005).

Shugan, S.M. Product assortment in triopoly, Management Science, 35, 304- 320, (1989).

Stole, L. Lectures on contracts and organizations, (2000), http://gsblas.uchicago.edu/papers/lectures.pdf.

Young, P. The evolution of conventions, Econometrica, 61, 57-84, (1993).