High Price Strategy and Quality Signalling

I investigate a high price strategy by a durable‐goods producer for signalling the high quality of goods. It is assumed that two types of monopolists exist: high‐quality and low‐quality. The monopolist's type is assumed to be unknown to consumers in the first period. Before the beginning of the second period, a product reputation established in the past period enables consumers to recognize the real type of the monopolist. I show that there occurs a signalling equilibrium where the high‐quality type monopolist uses a high price strategy. An interaction between the new and old products peculiar to the durable‐goods markets plays an important role in the pricing strategy.     

A NOTE ON PRICING OF PRODUCT QUALITY FOR STATUS CONCERNS

The paper analyses the optimal pricing of the product quality scheme when concerns for relative standing exist among consumers. We demonstrate that if the proportion of high‐value consumers is over (respectively, under) 1/2 of the total consumers, a firm has an incentive to select a large (respectively, small) quality gap among products. Therefore, there exists a cut‐off level for status concerns, which eliminates quality differences, and the firm assigns the same quality to all the consumers. These results indicate that consumers’ qualities will reflect distortions at the top and bottom. Accordingly, the firm's profit depends on which consumer category is larger.     

PRICE FLOORS AND QUALITY CHOICE

This paper studies effects of price floors in a simple model of vertical product differentiation. We find that even non‐binding price floor (i.e., minimum price set below the lowest Nash equilibrium price in the baseline model) can increase quality on the market, if the cost of quality is sufficiently low. Where a binding price floor does not increase the equilibrium quality, it makes consumers worse off. There is also a possibility of over‐investment into quality as a result of the binding minimum price.     

Umbrella branding and external certification

In a market environment with random detection of product quality, a firm can employ umbrella branding as a strategy to convince consumers of the high quality of its products. Alternatively, a firm can rely on external certification of the quality of one or both of its products. We characterize equilibria in which umbrella branding fully or partially substitutes for external certification. We also show that the potential to signal quality is improved if consumers condition their beliefs on the source of information, namely whether information comes from external certification or from random detection.     

A model of fashions and status

This paper presents a model of fashion cycles based on the idea that individuals purchase fashion goods because their displayed status increases with the personal status of other consumers who buy the same good. Fashion cycles occur in the model because demand now is a rising function of future prices: if future prices are high, only rich consumers will buy it in the future and the good will have a higher status value in the future and will be more desirable now, even though demand now is a decreasing function of current price. The time inconsistency problem is solved by repeated cycles which allows for reputation building. The crucial assumption made is that there is perfect information about the price path of all firms and the average status of the purchasers of each product. This limits possible profits in fashion markets in competition as imitation of price paths is then possible.     

ENTRY AND QUALITY SIGNALLING WHEN ONLY SOME CONSUMERS ARE INFORMED OF THE ENTRANT'S QUALITY

This paper focuses on competition between an incumbent and an entrant when only the entrant's quality is unknown to (some) consumers. The incumbent may or may not know the entrant's quality. The model reveals a separating equilibrium where the entrant's high price signals its high quality when the proportion of informed consumers is at some intermediate value. The case in which the incumbent knows the entrant's quality generates two additional equilibria. When the proportion of informed consumers is large enough, firms choose their prices as in the complete information case. The entrant's high price in combination with the incumbent's low price signals the entrant's high quality. When the proportion of informed consumers is at some intermediate value, the incumbent's high price signals the entrant's low quality, while its low price signals the entrant's high quality. Interestingly, we find that entry may be facilitated with informational product differentiation.     

Price versus quantity in a duopoly of vertical differentiation with loss-averse consumers

In a model à la Mussa and Rosen (1978) in which consumers are loss-averse, I check the robustness of the result obtained by Tanaka (2001). As he did, I find that the quantity contract is a dominant strategy for both firms. Thus, Cournot is the outcome in equilibrium. Finally, I find that loss aversion in general intensifies competition.     

Nonlinear pricing with self-control preferences

A basic assumption of economics is that consumers choose what they want. However, many consumers find it difficult to stop overeating, overspending, smoking, procrastinating, etc, even though they want to. In reality, consumers have temptation and it is psychologically costly to exercise self-control. To clarify the implications of the existence of temptation and self-control costs, this paper studies a firm's optimal selling strategy exploiting the behavioral features of consumers. We characterize optimal nonlinear pricing schemes for a monopoly when self-control is costly for consumers. Since consumers have a preference for commitment, the firm faces a trade-off between offering a small menu that makes the consumers’ self-control easier and offering a large menu that achieves better price discrimination. We show that the optimal menu resembles the one in the standard nonlinear pricing problem with a price ceiling, where the upper bound on prices is determined endogenously by a participation constraint. The ceiling motivates the firm to offer a relatively flat and compact price schedule, serving more consumers with low demand. The characterization also shows that the firm may earn less if consumers have temptation.     

Will Gradualism Work When Shock Therapy Doesn’t?

When shock therapy is politically infeasible, will gradualism work? This paper takes up this question by: (i) building a political economy model in which it makes sense; (ii) stating the relevant political economy constraint rigorously; and (iii) analyzing the question in the context of a neoclassical model of adjustment, based on Mussa (1978). The paper answers the question in the affirmative, thus contributing to the scientific and policy literature on the economic analysis of policy reform.     

Product line pricing in a vertically differentiated oligopoly

Abstract This paper examines the joint pricing decision of products in a firm’s product line. When products are distinguished by a vertical characteristic, those with higher values of that characteristic will command higher prices. We investigate whether, holding the value of the characteristic constant, there is an additional price premium for products on the industry and/or the firm frontier, that is, for the products with the highest value of the characteristic in the market or in a firm’s product line. We also investigate the existence of price premia for lower‐ranked products and other product line pricing questions. Using personal computer price data, we show that prices decline with the distance from the industry and firm frontiers, even after holding absolute quality constant. We find evidence that consumer tastes for brands is stronger for the consumers of frontier products (and thus competition between firms weaker in the top end of the market). There is also evidence that a product’s price is higher if a firm offers products with the immediately faster and immediately slower computer chip (holding the total number of a firm’s offerings constant), possibly as an attempt to reduce cannibalization. Finally, a product’s price declines with the time it is offered by a firm, suggesting intertemporal price discrimination.     

The option of joint purchase in vertically differentiated markets

Summary. Within the framework proposed by Mussa and Rosen (1978) for modelling quality differentiation, consumers are assumed to make mutually exclusive purchases. A unique pure strategy equilibrium exists in this case. In this note, we allow consumers to buy simultaneously different variants of the differentiated good. We call this the “joint purchase option”. The paper proposes a detailed analysis of price competition when this option is opened: first, we show that either uniqueness, or multiplicity, or absence of price equilibrium arise, depending on the utility derived from joint purchase relative to exclusive purchase. Second, we characterize these equilibria, whenever they exist. Received: July 25, 2001; revised version: October 21, 2002 RID="*" ID="*" The second author gratefully acknowledges the financial support from Interuniversity Attraction Pole Program- Belgian State- Federal Office for Scientific, Technical and Cultural Affairs under contract PAI 5/26. Correspondence to: X.Y. Wauthy     

The secular inflation term in open-economy Phillips curves

Robert Flood has compared three alternative specifications for the secular inflation term in an open-economy Phillips curve, attributed, respectively, to Buiter-Miller, and Frankel and Mussa. We point out (1) an arithmetic error, (2) the equivalence of the Frankel and Mussa versions, and (3) some arguments against the Buiter-Miller version.     

The monopolist is not the best environmentalist’s best friend: An example

This letter addresses the second-degree price discrimination issue when a monopolized product is tied with environmental quality. The monopolist may degrade environmental quality too much when marginal valuations of environmental quality and the good itself are positively related across consumers.     

Advance-purchase discounts as a price discrimination device

In an intertemporal setting in which individual uncertainty is resolved over time, advance-purchase discounts can serve to price discriminate between consumers with different expected valuations for the product. Consumers with a high expected valuation purchase the product before learning their actual valuation at the offered advance-purchase discount; consumers with a low expected valuation will wait and purchase the good at the regular price only in the event where their realized valuation is high. We characterize the profit-maximizing pricing strategy of the monopolist. Furthermore, adopting a mechanism design perspective, we provide a necessary and sufficient condition under which advance-purchase discounts implement the monopolist's optimal mechanism.     

Platform intermediation in a market for differentiated products

We study a two-sided market where a platform attracts firms selling differentiated products and buyers interested in those products. In the subgame perfect equilibrium of the game, the platform fully internalises the network externalities present in the market and firms and consumers all participate in the platform with probability one. The monopolist intermediary extracts all the economic rents generated in the market, except when firms and consumers can trade outside the platform, in which case consumers obtain a rent that corresponds to the utility they would get if they did trade outside the platform. The market allocation is constraint-efficient in the sense that the monopoly platform does not introduce distortions over and above those arising from the market power of the differentiated product sellers. An increase in the number of retailers increases the amount of variety in the platform but at the same time increases competition. As a result, the platform lowers the firm fees and raises the consumer charges. In contrast, an increase in the extent of product differentiation raises the value of the platform for the consumers but weakens competition. In this case, the platform raises both the charge to the consumers and the fee for the firms.     

Optimal quality threshold of admission in a two-sided farmers’ market

We develop a two-sided model for a farmers’ market where farmers value the number of consumers, and consumers value the number of farmers and the average product quality in the market. Consumer preference over product quality provides an incentive for the farmers’ market to exclude farmers of the lowest product quality. Using the model, we identify what factors the farmers’ market has to consider in determining the optimal quality threshold of admission, an issue that has not received any formal study. Those factors include the network effects between farmers and consumers, consumer preference over product quality and variety, and the quality spread among farmers. We also outline an empirical estimation strategy in order to make use of the model developed in this study.     

IMPERFECT SUBSTITUTES FOR PERFECT COMPLEMENTS: SOLVING THE ANTICOMMONS PROBLEM

An integrated monopoly, where two complements forming a composite good are offered by a single firm, is typically welfare superior to a complementary monopoly. This is ‘the tragedy of the anticommons’. We analyse the robustness of such result when competition is introduced for one or both complements. Particularly, competition in only one of the two markets may be welfare superior to an integrated monopoly if and only if the substitutes differ in their quality so that, as their number increases, average quality and/or quality variance increases. Then, absent an adequate level of product differentiation, favouring competition in some sectors while leaving monopolies in others may be detrimental for consumers and producers alike. Instead, competition in both markets may be welfare superior if goods are close substitutes and their number in each market is sufficiently high, no matter the degree of product differentiation.     

Geographical separation of oligopolists can be very competitive

A given number of single, differentiated product oligopolists locate in one of two separate market-places, which consumers access at a cost. Firms set prices and the CES consumers choose purchases at one or both market-places. Firm agglomeration in one market-place produces positive profits because of product differentiation. But if consumer access costs are homogeneous and products are sufficiently good substitutes, geographical separation of firms produces prices analogous to homogeneous product Bertrand, and is “very competitive”, the reverse of textbook Hotelling. Hence a novel explanation emerges for the geographical agglomeration of firms producing very similar products.     

REVENUE DIVERGENCE AND COMPETITIVE BALANCE IN A DIVISIONAL SPORTS LEAGUE

The North American model of resource allocation in professional sports leagues is adapted for English (association) football. Comparisons are drawn between the equilibrium allocations of playing talent under objective functions of profit maximisation and win percent maximisation subject to a financial constraint. Empirical revenue functions are reported for 1926–1999. These indicate a shift in the composition of demand favouring big‐city teams and an increase in the sensitivity of revenue to performance. An analysis of match results in the FA Cup suggests an increase in competitive imbalance between teams at different levels of the league's divisional hierarchy, as the theory suggests.