“Love for variety,” outside option and extensive margin of demand

What is it about?

The paper models a uniform-price Bertrand-price-competition in a differentiated product oligopoly market, where the buyers’ preference shows “love for variety”. The buyers differ from each other in their valuation of the differentiated product with a common outside option available to all. The model endogenously determines both the extensive and intensive margin of demand, and the equilibrium number of varieties at the differentiated product market. It shows that in such a framework complementarity exists at the extensive margin of demand even in the presence of demand substitutability between the varieties. The results apply to the competition between brick-and-mortar shops and malls.

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Why is it important?

The model relates to the real-life market situations, where the “love for variety” matters and the buyers choose between a ‘brick and mortar’ shop, selling a particular variety vis-à-vis a shopping mall/e-commerce platform selling a number of different varieties of a product. The results suggest that in presence of strong extensive margin of demand effect, the ‘brick and mortar’ shops, the shopping malls and the e-commerce platforms may complement each other, instead of being in conflict, as conventionally thought, and a price-cartel among the sellers of the differentiated product may not be a bad idea.

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