L11: Product Differentiation

Question 1

horizontal differentiation on a circle - Salop, 1979

Answer 1

hotelling only works for 2 firms so once you go above that, finding equilibrium is more difficult when working with mixed strategies

firms locate as far from each other as possible

valuation of good at v, linear transport costs t, consumer utility is v - p - t|x|

with small N, consumers may be far enough from any firm as to not buy at all
- firms are local monopolists

Question 2

what determines the level of prices in salop’s circle?

Answer 2

number of firms
- price decreases with more firms
- as N goes to infinity, price goes to MC and profits fall to 0 (back to perfect competition)

degree of differentiation
- determined by t, high t makes substitution costlier
- the bigger the transport cost, the less you’re competing with your neighbour since travelling is costly and you can charge higher prices
- as t goes to 0, price goes to MC and profits fall to 0

Question 3

free entry condition in Salop’s circle

Answer 3

any firm can enter as long as its efficient for them

profits as a function of the number of firms has to be 0

number of firms increases when consumers value differentiation more but decreases when entry becomes costlier

Question 4

utility function of a consumer in vertical differentiation

Answer 4

u = thetas - p
- theta as taste for quality individuals have
- s as quality
- p as price

Question 5

what do outcomes depend on in vertical differentiation?

Answer 5

price differences
- higher change in price means that fewer consumers buy the high quality good

vertical differentiation
- higher change in quality means that more consumers buy the high quality good

Question 6

why do we need heterogeneity in taste for quality (theta) for vertical differentiation?

Answer 6

otherwise, consumers only purchase one of the products since everyone agrees on the ranking and has the same taste
- heterogeneity gives us differentiation across goods

without differentiation, then profits are 0 since if quality is the same and MC is the same, we go back to bertrand

Question 7

if c1 = c2 = MC and quality if costless, would firm 1 increase quality?

Answer 7

the lower the quality for firm 1, the more differentiated they will be and firm 1 knows this
- wants to decrease quality to increase differentiation to increase profit

incentives for firm 2 to set quality at the highest and firm 1 at the opposite to increase differentiation

Question 8

Vertical Differentiation with Multiple Products - Bersnahan, 1987

Answer 8

explaining an increase in car sales in 1955 using changes in the competitive environment

data consistent with collusion in 1954 and 1956 but competition in 1955