Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/92977
Authors: 
Conze, Maximilian
Kramm, Michael
Year of Publication: 
2013
Series/Report no.: 
Bonn Econ Discussion Papers 14/2013
Abstract: 
Hotelling's famous 'Principle of Minimum Differentiation' suggests that two firms engaging in spatial competition will decide to locate at the same place. Interpreting spatial competition as modeling product differentiation, firms will thus offer products that are not differentiated and equally share the market demand. We extend (a fixed price version of) Hotelling's model by introducing sequential consumer purchases and a second dimension of variation of the goods, quality. Consumers have differential information about the qualities of the goods and uninformed consumers observe the decision of their predecessors. With this extension a rationale for differentiating products emerges: Differentiation makes later consumers' inference from earlier consumers' purchases more informative, so that firms are confronted with two offsetting effects. On the one hand, differentiating one's product decreases the likelihood that it is bought in earlier periods, but on the other hand, by making inference more valuable, it increases the likelihood that later consumers buy the differentiated good. We show that the second effect, the recommendation effect, can dominate, leading to an equilibrium with differentiated products. Our model thus introduces an aspect similar to the herding literature in that consumers might base their decisions on observable actions of others and thus potentially on 'wrong' decisions.
Subjects: 
Hotelling
Herding
Principle of Minimum Differentiation
Consumer Learning
JEL: 
L13
L15
D83
Document Type: 
Working Paper

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