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PRODUCT VARIETY AND DEMAND UNCERTAINTY: WHY MARKUPS VARY WITH QUALITY* |
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| Authors: | DENNIS W. CARLTON JAMES D. DANA JR. |
| Affiliation: | 1. The University of Chicago, Graduate School of Business, 1101 East 58th St., Chicago, Illinois 60637, U.S.A. e‐mail:dennis.carlton@gsb.chicago.edu;2. Department of Economics, Northeastern University, 360 Huntington Ave., Boston, Massachusetts 02115, U.S.A. e‐mail:j.dana@neu.edu |
| 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. |
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