When Does Variety Increase with Quality?

Abstract:     
Casual empiricism suggests higher quality is associated with greater variety. However, recent theoretical and empirical research has either not considered this link, or has been unable to establish unambiguous predictions about the relationship between quality and variety. In this paper we develop a simple model, which predicts that for low qualities variety should be positively correlated with quality and we establish conditions under which variety will either increase or decrease with quality at higher quality levels. The producer uses variety to increase the profitability of price discrimination across different qualities, by increasing the likelihood consumers choose high price products among products yielding the same utility. We show that the number of varieties offered by the monopolist is greater than the social optimum. The predictions of the model are supported by an empirical analysis of the market for cars. A wide range of car manufacturers are found to offer a hump-shaped distribution of varieties.

Number of Pages in PDF File: 43

Keywords: Price discrimination, product variety, bounded rationality, cars

JEL Classification: D4, D8, L11, L15, L62

working papers series