PRODUCT DIFFERENTIATION

why do we use spatial models?

- consumers have heterogenous tastes.

- products may differ in characteristics.

- consumers buy one unit of their preferred variety.

- firms choose locations in the product space.

what is the general setup of the hotelling's linear city model?

- products lie on a unit line [0,1].

- consumers are uniformly distributed along the line.

- consumers purchase on unit from their preferred product variety (highest utility).

- firms locate themsleves along the line based on their product variety.

- transportation cost is the dislike for mismatch.

- cost = 0

what variable is the strategic choice when prices a fixed? (exogenous prices model).

- location is the strategic choice.

what is the goal in the exogenous prices model? what choice do consumers make?

- to maximise market share.

- consumers purchase from the firm which is closest to them.

what is the indifferent consumer?

- the consumer that's neither prefers to consume from firm 1 or 2.

- they split the market in the middle.

- the aim is to shift the IC.

what are the three options of location for the firm?

what is the NE?

A.

Choose same as the other firm, not at the centre.

- either can move slightly inwards to shift the IC and capture more of the market.

- profitable deviation possible.

B.

Different locations. either can move in a bit to shift IC.

C.

Both at the centre.

- no profitable deviation.

- firms choose to cluster at the centre.

what would be the socially optimum result of the firm location choice?

- firms to be spread out to reduce transportation costs for consumers.

- clustering gives too little variety.

what is the strategic choice in the exogenous location model?

firms only choose their prices which they will set to consumers.

what is the setup of the fixed location hotelling model?

- firm 1 at 0, firm 2 at 1.

- consumers base purchase on distance and price.

- there is a consumer who is indifferent between the two firms.

what does maximal differentiation in the fixed location model do to pricing ability?

- prices are strategic complements. when one firm rises price, the other one can too.

- firms have capture market share due to large transportation costs.

- can set higher prices.

- firms earn higher profits.

what is the setup of the salop circle?

- firms are now located on a circle.

- consumers are equally distributed.

- each consumer has an ideal product location.

- each consumer purchases from the closest firm.

how does entry work in the salop circle?

there is free entry and firms choose to enter the market if profits cover fixed costs.

why do firms earn positive profit in the salop circle?

- differentiation softens price competition because each firm has local monopoly.

• undercutting now only steals a small part of demand as firms only compete with their neighbours.

how many firms to firms compete with in the salop circle?

they compete with only their neighbours and so price is higher than marginal cost.

undercutting becomes less profitable as only steal a few consumers.

what is the business stealing effect and how does it effect firms?

the entrant only cares that profit covers fixed costs. doesn’t care about how it effects the current incumbents. new entrants steal customers from existing firms, reducing total surplus. number of firms overall is inefficient. negative welfare effect.

what is the representative consumer model?

• one average consumer captures overall preferences.

• firms choose price strategically.

• prices move together.

• equilibrium prices are above cost.