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When Does Variety Increase with Quality?

Author

Listed:
  • Suren Basov

    (The University of Melbourne)

  • Svetlana Danilkina

    (The University of Melbourne)

  • David Prentice

    (Infrastructure Victoria)

Abstract

In this paper we provide a novel explanation of the relationship between product quality and variety. We develop a simple theoretical model with nearly rational consumers, who randomize among all alternatives that yield the same utility for them but could make a mistake of choosing a slightly worse alternative. We show that it is optimal for a firm to offer more varieties of its higher quality, more profitable, products, in order to price discriminate more effectively. When the market is thin at the very top quality level, the number of varieties first increases and then decreases, which results in the overall hump-shaped relationship between the number of varieties and quality. We find empirical support for our qualitative predictions in the Australian car market.

Suggested Citation

  • Suren Basov & Svetlana Danilkina & David Prentice, 2020. "When Does Variety Increase with Quality?," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 56(3), pages 463-487, May.
  • Handle: RePEc:kap:revind:v:56:y:2020:i:3:d:10.1007_s11151-019-09704-7
    DOI: 10.1007/s11151-019-09704-7
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    More about this item

    Keywords

    Price discrimination; Product variety; Bounded rationality; Nearly rational consumers; Cars;
    All these keywords.

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L62 - Industrial Organization - - Industry Studies: Manufacturing - - - Automobiles; Other Transportation Equipment; Related Parts and Equipment
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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