Product Variety and Demand Uncertainty: Why Markups Vary with Quality

18 Pages Posted: 12 Nov 2008  

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; Harvard Business School

Abstract

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.

Suggested Citation

Carlton , Dennis W. and Dana, James D., Product Variety and Demand Uncertainty: Why Markups Vary with Quality. The Journal of Industrial Economics, Vol. 56, Issue 3, pp. 535-552, September 2008. Available at SSRN: https://ssrn.com/abstract=1299273 or http://dx.doi.org/10.1111/j.1467-6451.2008.00353.x

Dennis W. Carlton (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
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National Bureau of Economic Research (NBER)

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James D. Dana Jr.

Northeastern University - Department of Economics ( email )

301 Lake Hall
Boston, MA 02115
United States
617-373-7517 (Phone)

HOME PAGE: http://www.economics.neu.edu/dana/

Northeastern University - Department of International Business and Strategy

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Boston, MA 02115
United States

Harvard Business School ( email )

Harvard Business School
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Boston, MA 02163
United States
617-495-6958 (Phone)

HOME PAGE: http://www.hbs.edu/faculty/Pages/profile.aspx?facId=438792

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