Product Variety and Demand Uncertainty: Why Markups Vary with Quality
Dennis W. Carlton
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
James D. Dana Jr.
Northeastern University - Department of Economics; Northeastern University - Department of International Business and Strategy
The Journal of Industrial Economics, Vol. 56, Issue 3, pp. 535-552, September 2008
We demonstrate that demand uncertainty can explain equilibrium product variety in the presence of sunk costs. Product variety is an efficient response to uncertainty because it reduces the expected costs associated with excess capacity. We find that within the firm's product line, the highest quality product has the highest profit margin but the lowest percentage margin, while the lowest quality product has the highest percentage margin but the lowest absolute margin. Both of these relationships are consistent with evidence available from marketing studies.
Number of Pages in PDF File: 18Accepted Paper Series
Date posted: November 12, 2008
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