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Effects of Increased Variety on Demand, Pricing, and Welfare

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We use order statistics to analytically derive demand functions when consumers choose from among the varieties of two brands—such as Coke and Pepsi—and an outside good. Soft-drinks have no price variability across varieties within a brand, so traditional demand systems (e.g., mixed logit) are not identified. In contrast, our demand system is identified and can be estimated using a nonlinear instrumental variable estimator. Our demand functions are higher-order polynomials, where the polynomial order is increasing in variety. Because these demand curves have convex and concave sections around an inflection point, firms are more likely to respond and make large price adjustments to increases in cost than to comparable decreases in costs. We compare the profit-maximizing number of varieties within a grocery store to the socially optimal number and find that consumer surplus and welfare would increase with more variety. Key Words: Varieties, Product Line, Consumer Surplus, Welfare, Demand, Order Statistics JEL No. L11, L66, D11

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Paper provided by Center for Policy Research, Maxwell School, Syracuse University in its series Center for Policy Research Working Papers with number 152.

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Length: 46 pages
Date of creation: Jan 2013
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Handle: RePEc:max:cprwps:152

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  1. Richard J. Gilbert and Carmen Matutes., 1989. "Product Line Rivalry with Brand Differentiation," Economics Working Papers 89-103, University of California at Berkeley.
  2. J. Miguel Villas-Boas, 2004. "Communication Strategies and Product Line Design," Marketing Science, INFORMS, vol. 23(3), pages 304-316, January.
  3. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  4. Botond Kőszegi & Paul Heidhues, 2008. "Competition and Price Variation When Consumers Are Loss Averse," American Economic Review, American Economic Association, vol. 98(4), pages 1245-68, September.
  5. Raubitschek, Ruth S, 1987. "A Model of Product Proliferation with Multiproduct Firms," Journal of Industrial Economics, Wiley Blackwell, vol. 35(3), pages 269-79, March.
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