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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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  9. Thierry Mayer & Gianmarco Ottaviano, 2008. "The Happy Few: The Internationalisation of European Firms," Intereconomics- Review of European Economic Policy, Springer;German National Library of Economics;Centre for European Policy Studies (CEPS), vol. 43(3), pages 135-148, May.
  10. Oliver Lorz & Matthias Wrede, 2009. "Trade and Variety in a Model of Endogenous Product Differentiation," MAGKS Papers on Economics 200902, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  11. Chad Syverson, 2004. "Market Structure and Productivity: A Concrete Example," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1181-1222, December.
  12. Ekholm, Karolina & Midelfart, Karen Helene, 2005. "Relative wages and trade-induced changes in technology," European Economic Review, Elsevier, vol. 49(6), pages 1637-1663, August.
  13. Martin L. Weitzman, 1994. "Monopolistic Competition with Endogenous Specialization," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 45-56.
  14. 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.
  15. 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.
  16. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
  17. Helble, Matthias & Okubo, Toshihiro, 2008. "Heterogeneous quality firms and trade costs," Policy Research Working Paper Series 4550, The World Bank.
  18. Paula Bustos, 2011. "The Impact of Trade Liberalization on Skill Upgrading Evidence from Argentina," Working Papers 559, Barcelona Graduate School of Economics.
  19. 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.
  20. Ina Simonovska, 2010. "Income differences and prices of tradables," Globalization and Monetary Policy Institute Working Paper 55, Federal Reserve Bank of Dallas.
  21. Rabah Amir & Val E. Lambson, 2000. "On the Effects of Entry in Cournot Markets," Review of Economic Studies, Oxford University Press, vol. 67(2), pages 235-254.
  22. Markusen, James R & Venables, Anthony J, 1997. "The Role of Multinational Firms in the Wage-Gap Debate," Review of International Economics, Wiley Blackwell, vol. 5(4), pages 435-51, November.
  23. 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.
  24. Amit Khandelwal, 2007. "The Long and Short (of) Quality Ladders," 2007 Meeting Papers 244, Society for Economic Dynamics.
  25. 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.
  26. Steven Berry & Joel Waldfogel, 2010. "PRODUCT QUALITY AND MARKET SIZE -super-," Journal of Industrial Economics, Wiley Blackwell, vol. 58(1), pages 1-31, 03.
  27. Lancaster, Kelvin, 1980. "Competition and Product Variety," The Journal of Business, University of Chicago Press, vol. 53(3), pages S79-103, July.
  28. 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.
  29. Yongmin Chen & Michael H. Riordan, 2008. "Price-increasing competition," RAND Journal of Economics, RAND Corporation, vol. 39(4), pages 1042-1058.
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