Chapter 14 - Product Differentiation Flashcards
characteristics approach
instead of estimating the demand for each individual good, we estimate the demand for each characteristic of the goods
hedonic prices
implicit prices of each characteristic, measured by regression
not all consumers value each characteristic equally, utilities per characteristic vary per customer, signalled by their coefficient in a regression
vertical product differentiation
corresponds to the case when consumers unanimously prefer more of a given characteristic
horizontal product differentiation
refers to the case when different buyers’ preferences for a given characteristic have different signs, that is some think it’s a good thing, some think it’s a bad thing
vertical product differentiation model
firms simultaneously set prices pi; consumers choose which product they want to buy from; and finally firms produce and supply the amount demanded, where each unit costs c to produce.
everyone agrees that a higher value of v implies a better product
unlike the Bertrand case a small change in price does not imply a …
big change in demand
aspects of the vertical product differentiation model
higher quality firms set higher prices
higher-valuation consumers purchase the higher-quality product
higher-valuation consumers are more sensitive to quality changes than lower valuation consumers
direct effect
the direct effect of an increase in v1 (quality) corresponds to the change in π1 that takes place if prices remain constant at their initial equilibrium level
strategic effect
corresponds to the effect of the equilibrium price adjustments following an increase in v1
in the limit when v1=v2, we are back to…
Bertrand competition
firms set prices equal to marginal cost and earn zero profits
The Hotelling model
customers' preferences are located by points on the same line segment. The same line is used to represent products (think of spatial product differentiation) the timing (rules of the game) are similar to the Bertrand model. Firms simultaneously set prices pi; consumers choose which firm they want to buy from; and finally firms produce and supply the amount demanded, where each unit costs c to produce.
the greater the degree of product differentiation, the … the degree of market power
greater
If price competition is very intense, then firms tend to locate (1). If price competition is not very intense, then firms tend to locate (2).
- far apart (high degree of differentiation)
2. close to each other (low degree of differentiation)
strategic trade policy
when oligopoly competitors belong to different countries, import tariffs to foreign competitors may have the effect of increasing the domestic firm’s profits at the expense of the foreign firms
search good
one whose features the consumer can ascertain before purchase
experience good
one whose features can only be ascertained upon consumption
informative advertising
describes the product’s existence, its characteristics
persuasive advertising
is designed to change consumer’s perception about the product’s value
branding
giving a meaning to specific organization, company, products or services by creating and shaping a brand in consumers’ minds.
implicit contract between buyer and seller
if brand is associated with quality products, the implicit contract is that the brand offer high-quality products; and consumers, expecting to receive high-quality products, pay a high price for it
umbrella branding
practice of selling several products under the same name
the advertising to sales ratio is greater the greater the (1) of demand and the lower the (2) of demand (or the greater the price-cost margin)
- advertising elasticity
2. price elasticity
advertising that provides information about characteristics tends tos soften price competition
the moment consumers perceive the different products as different, firms no longer have the incentive to undercut their rivals
advertising prices tend to intensify price competition
search cost
Search costs include the opportunity cost of the time and effort spent on searching plus any explicit costs of money or scarce resources expended in searching
price dispersion
situation whereby different firms set different prices for the same product
obfuscation
sellers purposefully make selling terms unclear
may be interpreted as a seller strategy to increase search costs and thereby soften the degree of competition
add-on pricing/shrouded attributes
features of a product or of the sales contract that are hidden from a consumer until after the purchase takes place
switching cost
combination of objective and subjective, monetary and non-monetary barriers to change from one brand to another (example: switching from a windows laptop to a macbook)
harvesting effect
due to switching costs, firms may increase prices without losing many of their current customers
investment effect
when competing for new customers, the expectation of future rents from captive customers leads firms to price more aggressively
when consumers are less than fully rational or perfectly informed, firms may have an opportunity to increase market power
consumer protection
in many ways competition is the ultimate form of consumer protection, but imperfect information about each firm’s supply may lead to market power and, more generally, may result in consumer harm
spurious product differentiation
identical products are perceived by consumers as different
