Abstract
In our discussion of monopolistic competition in the previous chapter, competing firms produced differentiated products. This occurs when firms sell products that vary slightly from one brand to another. Two loaves of wheat bread may be the same in every way except that one is thin sliced and the other is thick sliced. Although a Mazda Miata and Porsche 911 are both sports cars, they differ in terms of style, power, and fuel economy. This is in contrast to perfectly competitive markets, where products are perfectly homogeneous.
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Notes
- 1.
For a review of the literature and practical concerns with the law of one price, see Lamont and Thaler (2003).
- 2.
This information is available at http://www.edmunds.com.
- 3.
Of course, they have different packaging and are marketed in different ways. These issues will be discussed in later chapters.
- 4.
Thus, it is sometimes called a representative consumer model. Dixit (1979) derives this demand system from the representative consumer’s utility function U(q 1, q 2) = α 1 q 1 + α 2 q 2 − (β 1 q 21  + β 2 q 22  + 2γq 1 q 2)/2. In our specification, we let a = α 1 = α 2, β 1 = β 2 = 1, and d = γ.
- 5.
- 6.
In other words, consumers are making discrete purchases, buying 0 or 1 unit at a time. This is common with durable goods, for example, where most consumers buy just one house, automobile, or microwave oven at a time.
- 7.
This is derived as follows. From above, d m1 = θ m and d m2 = 1 − θ m . Thus, U m1 = s − p 1 − td m1 = s − p 1− tθ m and U m2 = s − p 2 − t(1−θ m ). Setting U m1 = U m2 and solving for θ m leads to the following result: θ m  = (t − p 1 + p 2)/(2t).
- 8.
In many applications, N is normalized to 1 for simplicity.
- 9.
When this happens, consumers may decide to buy a different good. For example, a substantial increase in the price of cookies will cause some consumers to switch to ice cream, which is called an outside good.
- 10.
That is, if the distance between firms 1 and 2 is 1/n, and the distance between firm 1 and consumer x is distance x, then the distance between firm 2 and consumer x is (1/n − x). We use x instead of θ x to simplify the notation.
- 11.
For example, the strength of preference for quality could be a positive function of consumer income, with richer consumers having a stronger preference (i.e., willingness and ability to pay) for quality.
- 12.
If φ L < x, the market would be uncovered because consumers with preferences within the x−φ L interval would opt out of the market (i.e., they would buy neither brand 1 nor brand 2).
- 13.
There are exceptions. In our discussion of damaged goods in Chap. 14, we show that it can be profitable for a multiproduct firm to produce and sell both a high and a low quality brands even though the low quality brand is more expensive to produce than the high quality brand.
- 14.
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Tremblay, V.J., Tremblay, C.H. (2012). Product Differentiation. In: New Perspectives on Industrial Organization. Springer Texts in Business and Economics. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-3241-8_7
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