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Product differentiation under imperfect information: When does offering a lower quality pay?

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  • Bing Jing

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    Abstract

    In this paper, we extend the Varian (1980) model to examine endogenous quality differentiation by firms, with a particular emphasis on the interplay between the firms’ product quality decisions and the ensuing price rivalry. Specifically, we assume that the price-sensitive (or informed) consumers hold a lower valuation for product quality than the brand-loyal (or uninformed) consumers. It is shown that the firms will choose differentiated qualities for a broad class of consumer utility functions and production technologies. We obtain two results. First, the equilibrium quality choices are efficient as they are also the welfare-maximizing qualities chosen by a social planner. The equilibrium qualities are as if one firm serves only its loyal consumers and the other serves only the price-sensitive consumers, even though they each serve both types of consumers (at least for some fraction of time). Second, the firm choosing the lower quality makes greater profits and also prices more aggressively, in the sense that it maintains a lower maximum price and offers discounts more often. The lower-quality product is more profitable because it yields higher social surplus when consumed by the price-sensitive consumers. Copyright Springer Science+Business Media, LLC 2007

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    File URL: http://hdl.handle.net/10.1007/s11129-006-9014-0
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    Bibliographic Info

    Article provided by Springer in its journal Quantitative Marketing and Economics.

    Volume (Year): 5 (2007)
    Issue (Month): 1 (March)
    Pages: 35-61

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    Handle: RePEc:kap:qmktec:v:5:y:2007:i:1:p:35-61

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    Web page: http://www.springerlink.com/link.asp?id=111240

    Related research

    Keywords: Imperfect information; Price promotion; Product differentiation;

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    Cited by:
    1. Bing Jing & Z. Zhang, 2011. "Product line competition and price promotions," Quantitative Marketing and Economics, Springer, vol. 9(3), pages 275-299, September.

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