An Undergraduate Primer on Quality-Differentiated Demand

Abstract

This article presents a student exercise on the logic underlying demand for quality-differentiated products. The argument builds and extends on basic constructs from undergraduate microeconomics, developing a linear demand structure to reflect consumer preferences for quality variation and a brief critique of market responses to those preferences that indicates potentially greater efficiency loses under monopoly once the possibility of quality distortions are accounted for. Various policy extensions are noted. These include applications in utility pricing tied to quality variations in service reliability, the potentially disproportionate impact on lower income households of quality distortions created by monopoly practices, and the potential of profligate resource use by monopolies which are shown to favor higher over lower quality products. Following along with the student exercise is a series of instructor notes with references to the scholarly literature and possible elaborations on various aspects of the exercise that instructors may chose to address. JEL Classifications: D4, D41, D42