Wednesday, November 9, 2011
Posted by D. Daniel Sokol
Joaquin Gomez Minambres Department of Economics, Universidad Carlos III de Madrid describes Temptation, horizontal differentiation and monopoly pricing.
ABSTRACT: We study the implications for pricing strategies and product offerings of consumers’ temptation when the differentiation of the product is horizontal. With horizontal differentiation, the temptation state is represented by a change in the consumers’ ideal product on the Hotelling line, so that consumers have two (possibly distinct) ideal products: one when committed and another when tempted. The firm faces the following trade-off: for the consumer who diverge the most between the ideal product with temptation and commitment, if the firm positions a product close to the consumer’s temptation ideal product, it increases the consumer’s surplus when tempted but decreases surplus with commitment, which lowers the consumer’s incentive to participate. This paper shows that, because of this trade-off, the firm may exclude products that are too close to the temptation preferences in the optimal menu. Moreover, it is sho! wn that product diversity and firm’s profits decrease with the probability of temptation and with the consumers’ awareness of their dynamic inconsistency.