Shahriyar Nasirov

Semana 10

1
 Content
• Product Differentiation
• Horizontal Differentiation
- Hotelling model
- Salop Model
• Vertical Differentiation
Diferenciación horizontal y
Vertical
Diferenciación horizontal y
Vertical
 Hotelling Model
The model:
1. “Linear city” is the interval [0,1]
2. Consumers are distributed uniformely along this interval.
3. There are 2 firms, located at each extreme who sell the
same good. The unique difference among firms is their
location.
4. c= cost of 1 unit of the good
5. t= transportation cost by unit of distance squared. This
cost is up to the consumer to pay. If a consumer is at a
distance d to one of the sellers, its transportation cost is
td2 . This cost represents the value of time, gasoline, or
adaptation to a product, etc.
6. Consumers have unit demands, they buy at most one
unit of the good {0,1}
 Hotelling Model
Graphically

Mass of
consumers =
1

 1dz  z 0  1  0  1
1
1
0

0 x 1

Location of firm B
Location of firm A
 Circular city model (Salop,
1979): assumptions
• Assumptions:
– Consumers are located with unit density around a circle. The
corresponding circumference measures N
– Firms are locates around the possible
– Consumer only can travel around the circel
– Each consumer buys a unit of the product that is identical except
for the location of the firm
– Per unit of distance transport cost is linear and equal to t
– Marginal costs are identical for all firms, ci=c
– Firms incur a cost F to enter the market
 Circular city model (Salop,
1979)
• Ejemplos:
– City located around a lake with an
inefficient system of ships
– Supermarkets located in the outbound of a
city with a city-center permanently
congested

8
Circular city model: demands
determination
• Salop’s model is a model of localized competition, in practice each of
firm has only two real competitors  the two firms surrounding it:

I
1/N 1/N
I-1 I+1
A B

 We determine the demands using the indifferent consumer condition:

• A consumer indifferent between purchasing from I or I-1
• B consumer indifferent between purchasing from I or I+1
 Vertical Differentiation

Consider two car producers. Each producer can produce a luxurious car or
cheap car ( only one type, however). There are 1,000 potential customers who
have identical preferences, but different incomes. Annual incomes of
consumers range from $ 10,000 to $ 50,000.

The consumer preferences given are by the following utility function. Consider
consumer with an income t. If the consumer buys a luxurious car obtains
utility of 4 (t - Pc). While buying a cheap car gives a utility of 2 (t - Pb). Pc> Pb

For simplicity we assume that the costs of producing cars are zero.

•Derivation of demand curves

•Problem of optimization in prices and equilibrium

Problem- Hotelling