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Endogenous Product Differentiation, Market Size and Prices

Recent empirical evidence suggests that prices for many goods and services are higher in larger markets. This paper provides an explanation for this phenomenon when firms can choose how much to differentiate their products in a monopolistically competitive environment. 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. Larger markets lead to greater variety and products that are more differentiated, which provides consumers with greater welfare despite the adverse effect of product differentiation on prices. The social planner does not charge a markup, which allows it to differentiate products more than is possible in the competitive equilibrium. The model also provides an explanation for why prices do not always fall when trade is liberalized.

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File URL: http://www2.ne.su.se/paper/wp10_26.pdf
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Paper provided by Stockholm University, Department of Economics in its series Research Papers in Economics with number 2010:26.

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Length: 27 pages
Date of creation: 09 Dec 2010
Date of revision:
Handle: RePEc:hhs:sunrpe:2010_0026
Contact details of provider: Postal: Department of Economics, Stockholm, S-106 91 Stockholm, Sweden
Phone: +46 8 16 20 00
Fax: +46 8 16 14 25
Web page: http://www.ne.su.se/
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  8. Lancaster, Kelvin, 1980. "Competition and Product Variety," The Journal of Business, University of Chicago Press, vol. 53(3), pages S79-103, July.
  9. Christian Broda & David E. Weinstein, 2006. "Globalization and the Gains from Variety," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 541-585, May.
  10. Rabah Amir, 2000. "On the Effects of Entry in Cournot Markets," Econometric Society World Congress 2000 Contributed Papers 1475, Econometric Society.
  11. 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.
  12. 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.
  13. 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".
  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.
  15. Ina Simonovska, 2011. "Income Differences and Prices of Tradables," Working Papers 1015, University of California, Davis, Department of Economics.
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  18. Chad Syverson, 2004. "Market Structure and Productivity: A Concrete Example," NBER Working Papers 10501, National Bureau of Economic Research, Inc.
  19. Michael W.M. Roos, 2003. "Regional price levels in Germany," ERSA conference papers ersa03p511, European Regional Science Association.
  20. Gianmarco Ottaviano & Thierry Mayer, . "The happy few: the internationalisation of European firms," Blueprints, Bruegel, number 12, June.
  21. 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.
  22. 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.
  23. Paula Bustos, 2011. "The Impact of Trade Liberalization on Skill Upgrading Evidence from Argentina," Working Papers 559, Barcelona Graduate School of Economics.
  24. 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).
  25. Steven Berry & Joel Waldfogel, 2010. "PRODUCT QUALITY AND MARKET SIZE -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 58(1), pages 1-31, 03.
  26. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
  27. Weitzman, Martin L, 1994. "Monopolistic Competition with Endogenous Specialization," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 45-56, January.
  28. 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.
  29. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
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