Cause of Under-Supply of Variety by Monopolist and Social Cost of It: High Cost or Low Demand?

Abstract

We show that a manager who has to pick a variety at a store without being able to choose the price of products on the horizontally differentiated market with positive fixed costs of offering each product will always under-provide variety. Using the information on sales and availability of vodka products at local Russian store chain we estimate how total sales in a store depend upon the number of products available in the vodka category. Then using the retail and wholesale prices information along with an assumption that the observed variety was maximizing manager's profit net of fixed costs we estimate the distribution of fixed cost of offering vodka variety and calculate the socially optimal level of variety. The average variety has decreased over the period of 6 years. At the same time demand for vodka has shrunk. we find that the unobserved part of fixed cost did not significantly increase over time thus the sole reason for lower variety is low demand. My estimates are that manager under-supplies variety by a factor of over 10, but the social welfare lost due to it is moderate 35% of maximal attainable one.