EFMD EQUIS CREDITED Industrial organization LEcture 7 Quality, Durability, and 满动 Warranties 學火旦 于 udan university
Binglin Gong Fudan University Industrial Organization Lecture 7 Quality, Durability, and Warranties
Quality In general brands are noncomparable on the basis of quality since each brand can be highly ranked because it has some features that are not available with other brands For this reason since multidimensional modeling of quality is very difficult, we will follow the literature and assume that quality can be measured by a real number Thus, we assume that a higher-quality product is indexed by a higher real number
Quality • In general, brands are noncomparable on the basis of quality since each brand can be highly ranked because it has some features that are not available with other brands. • For this reason, since multidimensional modeling of quality is very difficult, we will follow the literature and assume that quality can be measured by a real number. Thus, we assume that a higher-quality product is indexed by a higher real number
Personal Income and Quality Purchase Two firms producing brands with different qualities quality level k-H and quality level k=L,(h>L Two consumers: consumer 1 with high income 11, and consumer 2 with low income 12 where 1>12>0 Each consumer buys only one unit of the product The utility level of consumer i, 1=1, 2 is given by H(I-pH) if he buys the high-quality brand s L(-pl if he buys the low-quality brand. (121) For given prices, the marginal utility of quality rises with an increase in the consumer's income
Personal Income and Quality Purchase • Two firms producing brands with different qualities: quality level k = H and quality level k = L, (H > L > 0). • Two consumers: consumer 1 with high income I1, and consumer 2 with low income I2, where I1 > I2 > 0. • Each consumer buys only one unit of the product. The utility level of consumer i, i = 1, 2 is given by • For given prices, the marginal utility of quality rises with an increase in the consumer's income
Personal Income and Quality Purchase Proposition 12.1 1. If the low-income consumer buys the high quality brand, then the high-income Consumer 2. definitely buys the high-quality brand 3. If the high-income consumer buys the low- quality brand, then the low-income consumer definitely buys the low-quality brand
Personal Income and Quality Purchase Proposition 12.1 1. If the low-income consumer buys the highquality brand, then the high-income Consumer 2. definitely buys the high-quality brand. 3. If the high-income consumer buys the lowquality brand, then the low-income consumer definitely buys the low-quality brand
Personal Income and Quality Purchase Proof To prove part 1, let U()denote the utility level of consumer i when he buys the brand with lity k We want to show that U1(H)=H(I1-pB)>L(1-p)=U(L), From(12. 1)we have it that since consumer 2 buys the high-quality brand then it must be that U2(H)=H(I2-PH)>L(2-pr)=U2(L). (H-L)I2> HpH-LpL Since.>l. we have it that (H-LI>(H- LI2> HpH Therefore H(1-PH)>L(1-PL). This concludes the proof for the first part. The second part is left as an exercise in section 12.9
Personal Income and Quality Purchase
Personal Income and Quality Purchase Income differentiation plays a central role to sustain product differentiation At low average income levels both firms have incentives to support a policy which aims at Increasing average income since such an increase Is profitable to both of them; beyond some level, such an increase is no longer profitable to the low quality producer since more customers are rich enough to abandon the standard product for the high qualit one
Personal Income and Quality Purchase • Income differentiation plays a central role to sustain product differentiation. • At low average income levels, both firms have incentives to support a policy which aims at increasing average income since such an increase is profitable to both of them; beyond some level, such an increase is no longer profitable to the low quality producer since more customers are rich enough to abandon the standard product for the high quality one
Personal Income and Quality Purchase Gabszewicz and Thisse(1979, 1980)and Shaked and Sutton(1982) present models based on the utility function (12. 1)with more than two possible quality levels and show that even under free sequential entry, only a small number of different-quality brands will be produced
Personal Income and Quality Purchase • Gabszewicz and Thisse (1979, 1980) and Shaked and Sutton (1982) present models based on the utility function (12.1) with more than two possible quality levels and show that even under free sequential entry, only a small number of different-quality brands will be produced
Quality as vertical Product Differentiation Phlips and Thisse(1982)emphasized the distinction between horizontal and vertical product ifferentiation in the following way Differentiation is said to be horizontal if when the level of the product's characteristic is augmented in the product's space, there exists a consumer whose utility rises and there exists another consumer whose utility falls Differentiation is said to be vertical if all consumers benefit when the level of the product's characteristic is augmented in the product space
Quality as Vertical Product Differentiation • Phlips and Thisse (1982) emphasized the distinction between horizontal and vertical product differentiation in the following way: • Differentiation is said to be horizontal if, when the level of the product's characteristic is augmented in the product's space, there exists a consumer whose utility rises and there exists another consumer whose utility falls. • Differentiation is said to be vertical if all consumers benefit when the level of the product's characteristic is augmented in the product space
Quality as vertical Product Differentiation Figure 12. 1 illustrates a simple diagrammatic comparison between horizontal and vertical-quality differentiation(for a comprehensive discussion of horizontal and vertical differentiation see Beath and Katsoulacos 1991). In Figure 12. 1 all consumers are located between points 0 and 0 B 0 1 A B Figure 12.1 Horizontal versus vertical differentiation. Up: horizontal differentiation: Down: vertical differentiation brand B, whereas consumers located near brand B prefer brand B over brand A. In contrast, the t O The upper part of Figure 12. 1 is the same as the Hotelling horizontal-differentiation model display in Figure 7.7. In this case, given equal prices, the consumers located near firm A prefer brand A lower part of Figure 12. 1 illustrates an industry with vertically differentiated brands where all consumers prefer brand A over brand b(since all consumers are located closer to A than to B)
Quality as Vertical Product Differentiation
Quality as vertical Product Differentiation We modify the utility function in Hotelling model so that instead of having consumers gain a higher utility from the nearby brand all consumers would have their ideal brand located at point l on the [o 1] interval This modification would allow us to model product differentiation where firms still locate on the [o, 1] interval(and not outside this interval)
Quality as Vertical Product Differentiation • We modify the utility function in Hotelling model so that instead of having consumers gain a higher utility from the nearby brand, all consumers would have their ideal brand located at point 1 on the [0,1] interval. • This modification would allow us to model product differentiation where firms still locate on the [0,1] interval (and not outside this interval)