Product Line Rivalry and Market Segmentation—with an Application to Automobile Optional Engine Pricing

This paper addresses the questions whether and when the pricing practices on base products may differ from those of premium products, sold with options or add-ons. Various alternative models are considered: a monopoly model, a model of brand rivalry with full consumer information and a model of rivalry in which consumers are only well informed about base product prices. Only the brand rivalry model with limited consumer information predicts that premium products have larger percentage markups than base products, provided that brand rivalry is sufficiently intense. Empirical evidence on base and premium product pricing in the automobile market is consistent with the limited information model and inconsistent with the other two models.