Essays on quality and product differentiation.

Abstract

The three essays of my dissertation deal with different aspects of product differentiation models. Economists often begin their analysis of firm behavior after firms decide what products to sell, so that product choice is exogenous. To examine why firms sell different products, we must let firms choose the types of products they sell. Typically, economists break differences in products into two categories. First, firms can differentiate products horizontally. In horizontal product differentiation, when two products have the same price, consumers disagree about which one they prefer. Second, firms can differentiate products vertically. In vertical product differentiation, when two products have the same price, all consumers agree which product is better but disagree in how much they value higher quality. Most products are both horizontally and vertically differentiated. Consumers prefer different name brands (horizontal differentiation), while they agree which product is best within brands (vertical differentiation). The first two essays deal only with vertical product differentiation, while the third combines vertical and horizontal product differentiation. The first essay, Price and Quality Decisions by a Discriminating Monopolist: The Case of the Computer Software Industry, shows that in a static model a software monopolist often chooses not to discriminate between different types of consumers. It then examines how a software monopolist can use upgrades to help discriminate between consumers. The second essay is Vertical Product Differentiation and the Cost of Increasing Quality. The way in which an increase in quality affects a firm's cost function can lead to different results. I set up a cost function with a parameter that controls how much the cost of increasing quality affects fixed and marginal costs. I then analyze monopoly and competitive behavior for different values of the parameter. The third essay is Horizontal and Vertical Product Differentiation. More realistic models of product differentiation should incorporate both horizontal and vertical product differentiation. However, economists usually treat these as separate phenomena. I set up a model where consumers differ both in their preferences for brands and their willingness to pay for higher quality.