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Does add-on presence always lead to lower baseline prices? Theory and evidence

Marco Savioli () and Lorenzo Zirulia ()
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Lorenzo Zirulia: RCEA

Journal of Economics, 2020, vol. 129, issue 2, No 2, 143-172

Abstract: Abstract In many industries, firms give consumers the opportunity to add (at a price) optional goods and services to a baseline product. The aim of our paper is to clarify the effect that offering add-ons has on baseline prices. In order to do that, we develop a theoretical model of add-on pricing in competitive environments with two distinctive features. First, we discuss the choice of offering the add-on, if this entails a fixed cost. Second, we allow firms to have a varying degree of market power over the add-on. In symmetric equilibria, the presence of add-on always reduces baseline prices. In asymmetric equilibria in which only one firm offers the add-on, its presence increases the baseline price if the firm’s market power over the add-on is limited. The latter prediction of the model is confirmed by a hedonic price regression using a dataset of cruises offered worldwide, a situation in which it is possible to control for the level of add-on market power.

Keywords: Add-ons; Pricing; Cruise industry; Hedonic regression (search for similar items in EconPapers)
JEL-codes: D43 L83 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s00712-019-00678-4

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