Product Lines and Price Discrimination in Markets with Information Frictions

A well-known principle in economics is that firms differentiate their product offerings in order to relax competition. However, in this paper we show that information frictions can invalidate this principle. We build a duopolistic competition model of second-degree price discrimination with information frictions in which (i) an equilibrium always exists with overlapping product qualities, whereas (ii) an equilibrium with nonoverlapping product qualities exists only if both information frictions and the cost of providing high quality are sufficiently small. As a consequence, reasons other than an attempt to soften competition should explain why firms in some cases carry nonoverlapping product lines.

This paper was accepted by Matthew Shum, marketing.