Product Variety and Demand Uncertainty

Dennis Carlton and James Dana

No 10594, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that demand uncertainty leads to vertical product differentiation even when consumers are homogeneous. When a firm anticipates that its inventory or capacity may not be fully utilized, product variety can reduce its expected costs of excess capacity. When the firm offers a continuum of product varieties, the highest quality product has the highest profit margins but the lowest percentage margin, while the lowest quality product has the highest percentage margin but the lowest absolute margin. We derive these results in both a monopoly model and a variety of different competitive models. We conclude with a discussion of empirical predictions together with a brief discussion of supporting evidence available from marketing studies.

JEL-codes: D4 D8 (search for similar items in EconPapers)
Date: 2004-06
New Economics Papers: this item is included in nep-com and nep-mic
Note: IO
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Published as Carlton, Dennis W. and James D. Dana Jr. “Product Variety and Demand Uncertainty: Why Mark-ups Vary with Quality.” Journal of Industrial Economics (2008).

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