Description/Abstract
We use order statistics to analytically derive demand functions when consumers choose from among the varieties of two brands—such as Coke and Pepsi—and an outside good. Soft-drinks have no price variability across varieties within a brand, so traditional demand systems (e.g., mixed logit) are not identified. In contrast, our demand system is identified and can be estimated using a nonlinear instrumental variable estimator. Our demand functions are higher-order polynomials, where the polynomial order is increasing in variety. Because these demand curves have convex and concave sections around an inflection point, firms are more likely to respond and make large price adjustments to increases in cost than to comparable decreases in costs. We compare the profit-maximizing number of varieties within a grocery store to the socially optimal number and find that consumer surplus and welfare would increase with more variety.
Document Type
Working Paper
Date
1-2013
Keywords
Varieties, Product Line, Consumer Surplus, Welfare, Demand, Order Statistics
Language
English
Series
Working Papers Series
Disciplines
Economic Policy | Economics | Public Affairs, Public Policy and Public Administration
ISSN
1525-3066
Recommended Citation
Horrace, William C.; Hang, Rui; and Perloff, Jeffrey M., "Effects of Increased Variety on Demand, Pricing, and Welfare" (2013). Center for Policy Research. 390.
https://surface.syr.edu/cpr/390
Source
Local input
Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.
Additional Information
Working paper no. 152
The authors are grateful to Brian Wright for extremely helpful advice on welfare issues and to George Judge and Derek Laing for insightful discussions on order statistics.