The Max-Min Principle of Product Differentiation

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Abstract
We analyze two- and three-dimensional variants of Hotelling's model of differentiated products. In our setup, consumers can place different importance on each product attribute; this is measured by a weight in the disutility of distance in each dimension. Two firms play a two-stage game; they choose locations in stage 1 and prices in stage 2. We seek subgame- perfect equilibria. We find that all such equilibria have maximal differentiation in one dimension only; in all other dimensions, they have minimum differentiation. An equilibrium with maximal differentiation in a certain dimension occurs when consumers place sufficient importance (weight) on that attribute. Thus, depending on the importance consumers place on each attribute, in two dimensions there is a "max-min" equilibrium, a "min - max" equilibrium, or both. In three dimensions, depending on the weights, there can be a "max-min-min" equilibrium, a "min-max- min" equilibrium, a "min-min- max" equilibrium, any two of them, or all three. (This abstract was borrowed from another version of this item.)

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