Blue and Red Cars, or Blue Cars Only: A Note on Product Variety

Abstract

The number and variety of products observed at any point of time in a given industry results from a complex selection mechanism where various economic forces interact. Some of these forces proceed from the demand behaviour of the market. For instance, the need for product variety should increase, the larger the degree of income or taste differences between consumers. Similarly, product variety may be more desirable from the consumer's viewpoint, the smaller the degree of substitutability between the quantity of a given product and its quality (a copious meal may not compensate for second-rate food). On the other hand, the opening of a new product line is generally accompanied by important overhead costs; these costs may lead to a restriction in the variety of goods that it would otherwise be desirable to produce. Sometimes also a firm in a given industry may be constrained by technical feasibility or institutional reasons to produce a single, or a restricted, set of products only, though in other industries multi-product firms are allowed to cover the whole spectrum of goods. The product selection mechanism arising in the two types of industries should differ since, in the first case, competition between product lines takes place between different firms, and, in the second, the same competition arises inside the firm. These reasons make the problem of product selection one of the most difficult subjects of monopolistic competition. In spite of this difficulty, recent work in the field has opened avenues for further research. Of particular interest is the study of the welfare implications of this selection mechanism, and its links with price or quality regulation policies. In this respect, contributions by Sheshinski (1976) and Spence (1975) have revealed that, when monopolists have latitude in determining the quality attribute of their product, profit-maximizing decisions generally deviate from the social optimum in terms of quality assessments. On the other hand, Stern (1974) and Meade (1974) have provided examples showing that the variety of products that should be produced according to welfere criteria does not always coincide with the combination of products that is profitable to produce in an unregulated market. It is with these contributions that the present paper is concerned. The difference between social optimum and profitability is imputed by Meade to the interaction between two major forces: