Horizontal Product Differentiation

HorizontalProductDifferentiation

JavierElizalde*DepartmentofEconomics,UniversityofNavarra,Pamplona,Navarra,Spain

Abstract

Thisessayprovidesadefinitionofhorizontalproductdifferentiationandashortdescriptionofits

implicationsforLawandEconomics,asthedegreeofproductdifferentiationaffectsthedegreeof

competitionandthereforethelevelofprices.Ashortrevisionoftheliteratureonhorizontalproduct

differentiationisperformed.Theaimoftheliteratureistopredictthenumberofvarietiesorthedegreeof

differentiation(whenthenumberofvarietiesisfixed)inanindustry.Differentworksfinddifferent

solutionstothisproblem.

Definition

Horizontalproductdifferentiationtakesplacewhen,atagivenprice,someconsumerspreferdifferent

varietiesofthegoods.

Essay

Anumberofproductsarehorizontallydifferentiatedwhen,iftheywereallsoldatthesameprice,allof

themwouldbedemandedbyoneormoreconsumers.Theexistenceofhorizontalproductdifferentiation

impliesthatthemarketcannotbedescribedbyperfectcompetitionbutfirmsenjoysomedegreeofmarket

poweras,ifoneofthefirmsincreasesitsprice,someconsumerswouldswitchtoacompetitorbutsome

otherconsumerswouldkeeployaltotheiroriginalsupplier.

Fromthepointofviewoflawandeconomics,theexistenceofhorizontalproductdifferentiationis

relevantinordertoidentifythecompetitorsforgoodsandthereforetodefinetherelevantmarket.The

degreeofproductdifferentiationdeterminesthedegreeofmarketpower,asthemoresimilartheproducts,

themoreintensethepricecompetition.

Therearetwoalternativeapproachestotheanalysisofcompetitionwithdifferentiatedproducts.Thefirstapproachconsideredthatallconsumershadthesamepreferencesforthedifferentvarietiesofthe

goods,whichwerefixed(Bowley1924).Thisanalysiswasmodifiedbyconsideringendogenousvarieties

andfreeentry,inwhathasbeencalledintheliteraturethemodelofmonopolisticcompetition

(Chamberlin1933).Thesecondapproachtotheanalysisofhorizontalproductdifferentiationiscalled

theaddress(ordistance)approachasitconsidersthedegreeofproductdifferentiationasgeographical

distancebetweenthedifferentfirms(Hotelling1929).

Hotellinganalyzedproductswhichweredifferentiatedinonlyonedimension(inhisownexample,he

consideredthatcidercouldbesimplifiedtobedifferentiatedbythedegreeofsournessalone),and

differentconsumershaddifferentpreferencesforthedifferentvarietiesofthegoods.Intheoriginal

Hotellingmodel,twofirmsenteredsimultaneouslyinalinearmarketanddecidedtheproductcharacter-

isticinthefirststageandthepriceinthesecondstage.Anydecisiontochangetheproductspecification

*Email:

jelizalde@unav.esEncyclopediaofLawandEconomicsDOI10.1007/978-1-4614-7883-6_236-1#SpringerScience+BusinessMediaNewYork2015

Page1of2hasapriceeffectandamarketshareeffect:Afirmhasanincentivetoofferaclosersubstitutetoitsrival’s

productinordertogainsomeofitscustomers,butthisclosenessimpliesahigherdegreeofprice

competition.Themaingoaloftheaddressapproachtohorizontalproductdifferentiationhasbeento

definetheequilibriuminthecharacteristics(orlocation)game,whichrepresentsthedegreeofproduct

differentiationinthemarket.ThepredictionofHotellingwasthatthetwofirmswouldbelocatedinthe

centerofthelinearmarketimplyingminimumproductdifferentiation.Itwasshownthattheanalysisof

Hotellingfailedwhenthefirmswherecloselylocatedasnoneofthepriceormarketshareapproaches

dominatedtheother(d’Aspremontetal.1979).

TheanalysisofHotellingwasmodifiedinordertogetaperfectequilibriuminthetwostagesofthe

game.Oneoftheassumptionsthatweremodifiedwasthatthetransportationcostsofconsumersarelinear.

Byconsideringquadratictransportationcosts,d’Aspremont,Gabszewicz,andThissesolvedtheproblem

ofnonexistenceofequilibriumpredictingmaximumproductdifferentiation.Otherassumptionsofthe

originalwork(primarilytheexistenceoftwofirms,differentiationinasingledimension,simultaneous

entry,andthefactthatallconsumerspurchaseoneunitofthegoodsregardlessofprice)havebeenrelaxed

inrecentworksfindingsupportforeithermaximumorintermediatedegreesofproductdifferentiation

(PrescottandVisscher1977;Salop1979;Economides1984,1986;IrmenandThisse1998).

Therearetwonoteworthyversionsofthehorizontalproductdifferentiationanalysis:Theonethat

consideredfixedpricesandafixednumberoffirmsandlookedforthelocationequilibriumforeach

numberoffirms(EatonandLipsey1975)andthecircularmarketwithanendogenousnumberoffirms

(Salop1979).

References

BowleyA(1924)Themathematicalgroundworkofeconomics.OxfordUniversityPress,Oxford

ChamberlinE(1933)Thetheoryofmonopolisticcompetition.HarvardUniversityPress,Cambridge,MA

d’AspremontC,GabszewiczJJ,ThisseJF(1979)OnHotelling’s‘stabilityincompetition’.Econometrica

47:1145–1150

EatonB,LipseyR(1975)Theprincipleofminimumdifferentiationreconsidered:somenewdevelop-

mentsinthetheoryofspatialcompetition.RevEconStud42:27–49

EconomidesN(1984)Theprincipleofminimumdifferentiationrevisited.EurEconRev24:345–368