Thursday, August 28, 2014

Competition with Targeted Product Design: Price, Variety, and Welfare

Miguel Gonzalez‐Maestre, University of Murcia, Faculty of Business and Economics, Department of Economic Analysis and Luis M. Granero, Universitat de Valencia explore Competition with Targeted Product Design: Price, Variety, and Welfare

ABSTRACT: We consider the price and welfare effects of competition in targeted product design, in the context of the Salop circle model. With an exogenous number of firms, we show that under reasonable conditions price-increasing competition takes place, for intermediate levels of the number of firms. In turn, this effect is associated with the possibility of lower consumer welfare, as a result of increased competition. With endogenous firm entry, an interesting insight from our analysis is that an increase in market size or a technological progress that reduces entry costs both might reduce consumers’ welfare.

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I got an analogous result in my thesis, based on an industry model that considered the influence of product quality on both the demand and supply (cost) side of the market, but with endogenous industry structure. The intuition is that because under reasonable assumptions it is more costly to produce additional and/or higher-quality product variants, adding competitors detracts from the industry's technical capacity to produce higher-quality or additional product variants. I later discovered a Ph.D. thesis written at Columbia by Paul Dax, speculating along these same lines in light of clear evidence (from an international cross-section study) that legally protected monopolists -- specifically for tobacco products -- often provided more product variants over a wider range of product qualities, arguably providing greater consumer surplus than tobacco firms competing within open-entry regimes. The suggestion is that public policy should intervene to blockade entry if the desired goal is maximum consumer welfare, but it would be extremely difficult to be persuaded that such theoretical benefits outweigh other damaging effects not explicitly accounted for in the models.

Posted by: Tad Lipsky | Sep 10, 2014 3:04:41 PM

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