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Endogenous Product Differentiation, Market Size and Prices

Recent empirical evidence suggests that prices for some goods and services are higher in larger markets. This paper provides a demand-side explanation for this phenomenon when firms can choose how much to differentiate their products in a model of monopolistic competition with horizontal product differentiation. The model proposes that consumers’ love of variety makes them more sensitive to product differentiation efforts by firms, which leads to higher prices in larger markets. At the same time, endogenous product differentiation modeled in this way can lead to a positive and concave relationship between market size and entry.

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Paper provided by Research Institute of Industrial Economics in its series Working Paper Series with number 878.

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Length: 27 pages
Date of creation: 12 Aug 2011
Date of revision:
Handle: RePEc:hhs:iuiwop:0878
Contact details of provider: Postal: Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden
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  1. Yongmin Chen & Michael H. Riordan, 2008. "Price-increasing competition," RAND Journal of Economics, RAND Corporation, vol. 39(4), pages 1042-1058.
  2. Yongmin Chen & Michael H. Riordan, 2007. "Price and Variety in the Spokes Model," Economic Journal, Royal Economic Society, vol. 117(522), pages 897-921, 07.
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  4. Paula Bustos, 2011. "The Impact of Trade Liberalization on Skill Upgrading Evidence from Argentina," Working Papers 559, Barcelona Graduate School of Economics.
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  6. Ina Simonovska, 2010. "Income differences and prices of tradables," Globalization and Monetary Policy Institute Working Paper 55, Federal Reserve Bank of Dallas.
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  8. Rabah Amir & Val E. Lambson, 1998. "On the Effects of Entry in Cournot Markets," CIE Discussion Papers 1998-06, University of Copenhagen. Department of Economics. Centre for Industrial Economics.
  9. Markusen, James R. & Venables, Anthony, 1996. "The role of multinational firms in the wage-gap debate," Discussion Papers, Series II 322, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".
  10. Amit Khandelwal, 2010. "The Long and Short (of) Quality Ladders," Review of Economic Studies, Oxford University Press, vol. 77(4), pages 1450-1476.
  11. Marc J. Melitz & Gianmarco I.P. Ottaviano, 2005. "Market Size, Trade, and Productivity," Development Working Papers 201, Centro Studi Luca d\'Agliano, University of Milano.
  12. Bresnahan, Timothy F & Reiss, Peter C, 1991. "Entry and Competition in Concentrated Markets," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 977-1009, October.
  13. Richard Baldwin & James Harrigan, 2007. "Zeros, Quality and Space: Trade Theory and Trade Evidence," NBER Working Papers 13214, National Bureau of Economic Research, Inc.
  14. Jeffrey Campbell, 2000. "Market Size Matters," Econometric Society World Congress 2000 Contributed Papers 1225, Econometric Society.
  15. Michael W.M. Roos, 2003. "Regional price levels in Germany," ERSA conference papers ersa03p511, European Regional Science Association.
  16. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  17. Yunker, James A., 1979. "Variety, equity and efficiency: Product variety in an industrial society : By Kelvin Lancaster. New York: Columbia University Press, 1979. Pp. 373, Price: $22.50," Journal of Behavioral Economics, Elsevier, vol. 8(2), pages 195-197.
  18. Lorz Oliver & Wrede Matthias, 2009. "Trade and Variety in a Model of Endogenous Product Differentiation," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 9(1), pages 1-14, November.
  19. Chad Syverson, 2001. "Market Structure and Productivity: A Concrete Example," Working Papers 01-06, Center for Economic Studies, U.S. Census Bureau.
  20. Robert C. Feenstra, 2006. "New Evidence on the Gains from Trade," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 142(4), pages 617-641, December.
  21. Helble, Matthias & Okubo, Toshihiro, 2008. "Heterogeneous quality firms and trade costs," Policy Research Working Paper Series 4550, The World Bank.
  22. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
  23. Tabuchi, Takatoshi & Yoshida, Atsushi, 2000. "Separating Urban Agglomeration Economies in Consumption and Production," Journal of Urban Economics, Elsevier, vol. 48(1), pages 70-84, July.
  24. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  25. Harald Badinger, 2007. "Has the EU’s Single Market Programme Fostered Competition? Testing for a Decrese in Markup Rations in EU Industries," Working Papers 135, Oesterreichische Nationalbank (Austrian Central Bank).
  26. Lancaster, Kelvin, 1980. "Competition and Product Variety," The Journal of Business, University of Chicago Press, vol. 53(3), pages S79-103, July.
  27. Weitzman, Martin L, 1994. "Monopolistic Competition with Endogenous Specialization," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 45-56, January.
  28. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
  29. Steven Berry & Joel Waldfogel, 2010. "PRODUCT QUALITY AND MARKET SIZE -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 58(1), pages 1-31, 03.
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