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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
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Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden

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  4. Harald Badinger, 2007. "Has the EU’s Single Market Programme Fostered Competition? Testing for a Decrease in Markup Rations in EU Industries," Working Papers 135, Oesterreichische Nationalbank (Austrian Central Bank).
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  7. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  8. Rabah Amir, 2000. "On the Effects of Entry in Cournot Markets," Econometric Society World Congress 2000 Contributed Papers 1475, Econometric Society.
  9. Amit Khandelwal, 2010. "The Long and Short (of) Quality Ladders," Review of Economic Studies, Oxford University Press, vol. 77(4), pages 1450-1476.
  10. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
  11. Ina Simonovska, 2011. "Income Differences and Prices of Tradables," Working Papers 1015, University of California, Davis, Department of Economics.
  12. 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".
  13. Lancaster, Kelvin, 1980. "Competition and Product Variety," The Journal of Business, University of Chicago Press, vol. 53(3), pages S79-103, July.
  14. Ekholm, Karolina & Ulltveit-Moe, Karen-Helene, 2001. "Relative Wages and Trade-Induced Changes in Technology," CEPR Discussion Papers 2677, C.E.P.R. Discussion Papers.
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  16. Jeffrey Campbell, 2000. "Market Size Matters," Econometric Society World Congress 2000 Contributed Papers 1225, Econometric Society.
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  18. 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.
  19. Michael Roos, 2006. "Regional price levels in Germany," Applied Economics, Taylor & Francis Journals, vol. 38(13), pages 1553-1566.
  20. Gianmarco Ottaviano & Thierry Mayer, . "The happy few: the internationalisation of European firms," Blueprints, Bruegel, number 12.
  21. Paula Bustos, 2005. "The impact of trade liberalization on skill upgrading. Evidence from Argentina," Economics Working Papers 1189, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2011.
  22. 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.
  23. Chad Syverson, 2004. "Market Structure and Productivity: A Concrete Example," NBER Working Papers 10501, National Bureau of Economic Research, Inc.
  24. Yongmin Chen & Michael H. Riordan, 2008. "Price-increasing competition," RAND Journal of Economics, RAND Corporation, vol. 39(4), pages 1042-1058.
  25. 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.
  26. Robert C. Feenstra, 2006. "New Evidence on the Gains from Trade," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 142(4), pages 617-641, December.
  27. 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.
  28. Steven Berry & Joel Waldfogel, 2010. "PRODUCT QUALITY AND MARKET SIZE -super-," Journal of Industrial Economics, Wiley Blackwell, vol. 58(1), pages 1-31, 03.
  29. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
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