Outline. Product Differentiation I. Product Space. Monopolistic Competition (Chamberlin 1933) 10/2/2009

Transcription

1 0//009 Outline Product Differentiation I Industrial Organization K. Graddy Monoolistic Cometition (Chamberlin) Location Models Satial Aroach (Hotelling) Characteristics i Aroach h(l (Lancaster) Product Sace Two goods are almost never erfect substitutes Products intereract with other roducts in the economy How to describe differentiation? Monoolistic Cometition (Chamberlin 933) A reresentative consumer model Tyical consumer views all brands as equally good substitutes; brands are treated symmetrically, each consumer consumes a little bit of each roduct Model can be alied to differentiated or undifferentiated roducts Difference with oligooly: In oligooly model, number of firms is determined outside the model In Chamberlin s model, firms freely enter as long as it is rofitable for them to do so So, Entry Condition determines number of firms in the model Firms enter until rofit=0, so nis endogenously determined Model requires that firms face a downward sloing demand curve Downward sloing demand can be generated by roduct differentiation Can also be generated by high fixed costs that limit the number of firms that enter the industry; firms face a downward sloing residual demand curve i P ic * P i * Monoolistic Cometition AC Q c i Q i * D=D i ( i i)

2 0//009 Is it true that there are too many firms? Introduction of different goods can be justified even if roduction does not exhaust economies of scale So, for too many firms, must have homogeneous goods Here is one homogeneous as resented by CP This is a diversion from our roduct differentiation discussion Focus is on zero rofit condition Examle with homogeneous roducts q C( q) 0 Cq ( ) q Cq ( ) q AC Demand : Q Cost : Cq ( ) 0.8q F F.8 q To determine Q (and thus equilibrium number of firms), first determine the Cournot equilibrium outut for each ossible number of firms, then examine the equilibria and ick the one in which firms make zero rofits Equilibrium number of firms increases as fixed costs decrease Conventional wisdom: Leads to too many firms firm examle q q q q 000 C( q) 0.8q F Firm: R C q C( q) 000 q q ( ) q.8q F q q FOC : q( ) Reaction Functions : q q q q 80 q, q Table 7., P. 0, CP Solving simultaneously, q =q =40 Plugging into the demand function, =5 Then can find firm rofit for various levels of fixed costs. The monoolistically cometitive equilibrium is where firm rofit =0. This oint will vary as fixed costs vary. CP works out with different levels of fixed costs and different numbers of firms.

3 0//009 F=$6.40 F=$.60 Price Firm Average Firm Firm # of Firms (cents) Outut costs Profit Profit Back to Product Differentiation In general, with roduct differentiation and monoolistic cometition, there can be two effects, working in oosite directions Product Diversity: Too many roducts? Assume each firm roduces one roduct each. The number of roducts may be too few or too many deending on which of the following effects dominates:. The non-aroriability of consumer surlus effect: not all consumer surlus is catured by the entrant, unless it can erfectly rice discriminate. This is a ositive externality which can cause socially too few roducts/firms to enter.. The business stealing effect: not all rofit catured by the firm is created by the firm. Some is taken from other existing firms. This is a negative externality leading to socially too many firms. Drawbacks of model: each consumer consumes all goods; cross elasticity of demand same for all inside goods: no near neighbour effects; articularly inaroriate for neighbourly roducts. Strength of model: Suitable for situations where consumer refers variety, analytically convenient. Horizontal Differentiation (Hotelling 99) Sho Sho Cost tx Cost t( x) 0 Let s be the surlus enjoyed by each consumer Utility of consumer located at x: s- tx s ( x) Deriving the demand function: Case : t, differences in rices are not "too high" There exists an indifferent consumer x ( x ) x ( )/t i i i Demands are D (, ) Nx D (, ) N[ x ] i i 3

4 0//009 s s s tx s t( x) 0 X i (, ) Case : If then sho has no demand Sho has demand D(, ) N if Sho has demand D(, ) Ns ( )/t if if Case 3: Each sho has local monooly ower (and the market is not covered Sho has demand Ns ( )/t if if s Sho has demand N(- ) if t s s s s t s S tx=0 0 0 N(s )/t N( (s )/t) How to rice? (with quadratic transortation costs) There exists an indifferent consumer x i ( xi) xi ( ) / t Firm: D (, ) N [ x] N[ ] t, ) N[( c( )/ t] FOC : c 0 Using symmmetry, cometitive rices and rofits (er customer) are c and t / Where to locate? Demand effect: This ushes firms to the centre to cature demand. Reasoning: Suose firms begin by being located at each end of the city. Firm can increase its share by moving toward the centre. Both firms end u at centre: zero differentiation. Strategic effect: This ushes firms towards the edges to soften rice cometition. Reasoning: Suose both firms begin by being located in the centre. The firms are undifferentiated, and a rice cut will cature all demand, so rices fall to marginal cost. If firm moves to the right, a rice cut will no longer cature all demand. 4

5 0//009 With quadratic costs, firms will locate at ends. However, the socially otimal level of differentiation (to minimize transortation costs) is at ¼ or ¾. In the quadratic case, the strategic effect outweighs the demand effect and there is little rice cometition. However, deends on functional form, and there are other cases that demand effect may outweigh strategic effect. The Characteristics Aroach to Nutrition Food : units of rotein, unit of vitamins Food : unit of rotein, units of vitamins Food 3: unit of rotein, unit of vitamins A consumer is indifferent between unit of foods and and 3 units of food 3 Characteristics Aroach Goods are a bundle of characteristics Individuals are not interested in goods for their own sake, but for the characteristics they ossess Individuals have references for collections of characteristics Preferences for goods derive from references for characteristics Good examles Vitamins Comuters Bd Bad examles Fragrances Status goods Examles Summary We have looked at Chamberlain s model of monoolistic cometition a Reresentative Consumer Model Hotelling s satial aroach Lancaster s roduct characteristics aroach 5