Linking price dispersion to product differentiation - incorporating aspects of customer involvement

Abstract

The fact that product differentiation can cause price dispersion - price differences between alternative brands of what are seemingly identical products - is not surprising. Our contribution is to establish not whether, but how, it does so. We explore the mechanisms involved using a variant of Hotelling's market line model. We make no explicit assumptions about the functional form of the consumer's utility function so that we derive a general relationship between price dispersion and product differentiation. We then survey 16 product groups to identify the functional form of the consumer's utility function that allows our result to best fit real-world circumstances. We show that it is not product differentiation per se that causes price dispersion but rather the presence of a differential advantage of one product over another. More importantly, we show that the impact of a differential advantage in causing price dispersion is amplified (or attenuated) by an aspect of customer involvement in a purchase. The greater the customer involvement in a purchase the more amplified is the impact of product differentiation on price dispersion but this is sensitive only to logarithmic (roughly, order of magnitude) changes in customer involvement.