Product differentiation under imperfect information: When does offering a lower quality pay?
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
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Gerard J. Tellis & Birger Wernerfelt, 1987. "Competitive Price and Quality Under Asymmetric Information," Marketing Science, INFORMS, vol. 6(3), pages 240-253.
- Gerard R. Butters, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 465-491.
- Steven Salop & Joseph Stiglitz, 1977. "Bargains and ripoffs: a model of monopolistically competitive price dispersion," Special Studies Papers 94, Board of Governors of the Federal Reserve System (U.S.).
- Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
- Greg M. Allenby & Peter E. Rossi, 1991. "Quality Perceptions and Asymmetric Switching Between Brands," Marketing Science, INFORMS, vol. 10(3), pages 185-204.
- Elizabeth K. Kiser, 1998. "Heterogeneity in Price Sensitivity and Retail Price Discrimination," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 80(5), pages 1150-1153.
- Austan Goolsbee & Judith Chevalier, 2002.
"Measuring Prices and Price Competition Online: Amazon and Barnes and Noble,"
Yale School of Management Working Papers
ysm290, Yale School of Management, revised 12 Sep 2008.
- Austan Goolsbee & Judith Chevalier, 2002. "Measuring Prices and Price Competition Online: Amazon and Barnes and Noble," NBER Working Papers 9085, National Bureau of Economic Research, Inc.
- Steven Salop & Joseph Stiglitz, 1977. "Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 493-510.
- Greg Shaffer & Z. John Zhang, 2002. "Competitive One-to-One Promotions," Management Science, INFORMS, vol. 48(9), pages 1143-1160, September.
- Yuxin Chen & Chakravarthi Narasimhan & Z. John Zhang, 2001. "Consumer Heterogeneity and Competitive Price-Matching Guarantees," Marketing Science, INFORMS, vol. 20(3), pages 300-314, June.
- Joel Sobel, 1984. "The Timing of Sales," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 353-368.
- Nitin Mehta & Surendra Rajiv & Kannan Srinivasan, 2003. "Price Uncertainty and Consumer Search: A Structural Model of Consideration Set Formation," Marketing Science, INFORMS, vol. 22(1), pages 58-84, June.
- Yuxin Chen & Ganesh Iyer & V. Padmanabhan, 2002. "Referral Infomediaries," Marketing Science, INFORMS, vol. 21(4), pages 412-434, May.
- Il-Horn Hann & Kai-Lung Hui & Sang-Yong Tom Lee & Ivan P.L. Png, 2005. "Sales and Promotions: A More General Model," Industrial Organization 0508014, EconWPA.
- Erdem, Tulin & Imai, Susumu & Keane, Michael, 2003.
"Brand and Quantity Choice Dynamics Under Price Uncertainty,"
52516, University Library of Munich, Germany.
- Tülin Erdem & Susumu Imai & Michael Keane, 2003. "Brand and Quantity Choice Dynamics Under Price Uncertainty," Quantitative Marketing and Economics, Springer, vol. 1(1), pages 5-64, March.
- Peter Diamond, 1987.
"Consumer Differences and Prices in a Search Model,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 102(2), pages 429-436.
- Ganesh Iyer & Amit Pazgal, 2003. "Internet Shopping Agents: Virtual Co-Location and Competition," Marketing Science, INFORMS, vol. 22(1), pages 85-106, November.
- Michael Smith & Erik Brynjolfsson, 1999.
"Frictionless Commerce? A Comparison of Internet and Conventional Retailers,"
Computing in Economics and Finance 1999
1022, Society for Computational Economics.
- Erik Brynjolfsson & Michael D. Smith, 2000. "Frictionless Commerce? A Comparison of Internet and Conventional Retailers," Management Science, INFORMS, vol. 46(4), pages 563-585, April.
- Jagmohan S. Raju & V. Srinivasan & Rajiv Lal, 1990. "The Effects of Brand Loyalty on Competitive Price Promotional Strategies," Management Science, INFORMS, vol. 36(3), pages 276-304, March.
- J. Miguel Villas-Boas & Udo Schmidt-Mohr, 1999. "Oligopoly with Asymmetric Information: Differentiation in Credit Markets," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 375-396, Autumn.
- Asher Wolinsky, 1984. "Product Differentiation with Imperfect Information," Review of Economic Studies, Oxford University Press, vol. 51(1), pages 53-61.
- Narasimhan, Chakravarthi, 1988. "Competitive Promotional Strategies," The Journal of Business, University of Chicago Press, vol. 61(4), pages 427-49, October.
- Rami Zwick & Amnon Rapoport & Alison King Chung Lo & A. V. Muthukrishnan, 2003. "Consumer Sequential Search: Not Enough or Too Much?," Marketing Science, INFORMS, vol. 22(4), pages 503-519, October.
- Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-59, September.
- Robert, Jacques & Stahl, Dale O, II, 1993. "Informative Price Advertising in a Sequential Search Model," Econometrica, Econometric Society, vol. 61(3), pages 657-86, May.
- Png, I P L & Hirshleifer, D, 1987. "Price Discrimination through Offers to Match Price," The Journal of Business, University of Chicago Press, vol. 60(3), pages 365-83, July.
- Stahl, Dale O, II, 1989. "Oligopolistic Pricing with Sequential Consumer Search," American Economic Review, American Economic Association, vol. 79(4), pages 700-712, September.
- Rajiv Lal & J. Miguel Villas-Boas, 1998. "Price Promotions and Trade Deals with Multiproduct Retailers," Management Science, INFORMS, vol. 44(7), pages 935-949, July.
- Villas-Boas, J Miguel, 1995. "Models of Competitive Price Promotions: Some Empirical Evidence from the Coffee and Saltine Crackers Markets," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(1), pages 85-107, Spring.
- Lal, Rajiv & Villas-Boas, J Miguel, 1996. "Exclusive Dealing and Price Promotions," The Journal of Business, University of Chicago Press, vol. 69(2), pages 159-72, April.
- Michael R. Baye & John Morgan, 2001. "Information Gatekeepers on the Internet and the Competitiveness of Homogeneous Product Markets," American Economic Review, American Economic Association, vol. 91(3), pages 454-474, June.
- Birger Wernerfelt, 1994. "Selling Formats for Search Goods," Marketing Science, INFORMS, vol. 13(3), pages 298-309.
- Jianan Wu & Arvind Rangaswamy, 2003. "A Fuzzy Set Model of Search and Consideration with an Application to an Online Market," Marketing Science, INFORMS, vol. 22(3), pages 411-434, March.
- J. Yannis Bakos, 1997. "Reducing Buyer Search Costs: Implications for Electronic Marketplaces," Management Science, INFORMS, vol. 43(12), pages 1676-1692, December.
- A. M. McGahan & Pankaj Ghemawat, 1994. "Competition to Retain Customers," Marketing Science, INFORMS, vol. 13(2), pages 165-176.
- Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
- Rosenthal, Robert W, 1980. "A Model in Which an Increase in the Number of Sellers Leads to a Higher Price," Econometrica, Econometric Society, vol. 48(6), pages 1575-79, September.
When requesting a correction, please mention this item's handle: RePEc:kap:qmktec:v:5:y:2007:i:1:p:35-61. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla)or (Rebekah McClure)
If references are entirely missing, you can add them using this form.