Product Variety and Demand Uncertainty
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
NBER Working Paper No. w10594
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.
Number of Pages in PDF File: 40
Date posted: July 8, 2004