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Pricing Damaged Goods

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  • McAfee, R. Preston

Abstract

Companies with market power occasionally engage in intentional quality reduction of a portion of their output as a means of offering two qualities of goods for the purpose of price discrimination, even absent a cost saving. This paper provides an exact characterization in terms of marginal revenues of when such a strategy is profitable, which, remarkably, does not depend on the distribution of customer valuations, but only on the value of the damaged product relative to the undamaged product. In particular, when the damaged product provides a constant proportion of the value of the full product, selling a damaged good is unprofitable. One quality reduction produces higher profits than another if the former has higher marginal revenue than the latter.

Suggested Citation

  • McAfee, R. Preston, 2007. "Pricing Damaged Goods," Economics Discussion Papers 2007-2, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:5516
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    References listed on IDEAS

    as
    1. Justin P. Johnson & David P. Myatt, 2003. "Multiproduct Quality Competition: Fighting Brands and Product Line Pruning," American Economic Review, American Economic Association, vol. 93(3), pages 748-774, June.
    2. Armstrong, Mark & Vickers, John, 2001. "Competitive Price Discrimination," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 579-605, Winter.
    3. Motta, Massimo, 1993. "Endogenous Quality Choice: Price vs. Quantity Competition," Journal of Industrial Economics, Wiley Blackwell, vol. 41(2), pages 113-131, June.
    4. Justin P. Johnson & David P. Myatt, 2006. "Multiproduct Cournot oligopoly," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 583-601, September.
    5. Jong‐Hee Hahn, 2006. "Damaged durable goods," RAND Journal of Economics, RAND Corporation, vol. 37(1), pages 121-133, March.
    6. repec:rje:randje:v:37:y:2006:1:p:121-133 is not listed on IDEAS
    7. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    8. Jing, Bing, 2007. "Network externalities and market segmentation in a monopoly," Economics Letters, Elsevier, vol. 95(1), pages 7-13, April.
    9. Armstrong, Mark, 1996. "Multiproduct Nonlinear Pricing," Econometrica, Econometric Society, vol. 64(1), pages 51-75, January.
    10. Varian, Hal R, 1985. "Price Discrimination and Social Welfare," American Economic Review, American Economic Association, vol. 75(4), pages 870-875, September.
    11. Srinagesh, Padmanabhan & Bradburd, Ralph M, 1989. "Quality Distortion by a Discriminating Monopolist," American Economic Review, American Economic Association, vol. 79(1), pages 96-105, March.
    12. Raymond J. Deneckere & R. Preston McAfee, 1996. "Damaged Goods," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 5(2), pages 149-174, June.
    13. Besanko, David & Donnenfeld, Shabtai & White, Lawrence J, 1988. "The Multiproduct Firm, Quality Choice, and Regulation," Journal of Industrial Economics, Wiley Blackwell, vol. 36(4), pages 411-429, June.
    14. Kim, Jong Seok, 1987. "Optimal Price-Quality Schedules and Sustainability," Journal of Industrial Economics, Wiley Blackwell, vol. 36(2), pages 231-244, December.
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    Cited by:

    1. Lachapelle, A. & Santambrogio, F., 2011. "On the strategic use of risk and undesirable goods in multidimensional screening," Journal of Mathematical Economics, Elsevier, vol. 47(6), pages 698-705.
    2. Belleflamme,Paul & Peitz,Martin, 2015. "Industrial Organization," Cambridge Books, Cambridge University Press, number 9781107687899, May.
    3. Eric T. Anderson & James D. Dana, Jr., 2009. "When Is Price Discrimination Profitable?," Management Science, INFORMS, vol. 55(6), pages 980-989, June.
    4. McCalman, Phillip, 2010. "Trade policy in a "super size me" world," Journal of International Economics, Elsevier, vol. 81(2), pages 206-218, July.

    More about this item

    JEL classification:

    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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