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Vertical differentiation and production decisions

Product line price line and quality model. See attached file for full problem description.

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The model your teacher presented involves vertical differentiation. Vertical differentiation occurs in a market where the goods can be ordered according to their objective quality from the highest to the lowest, and customers differ in their marginal willingness to pay.

In general, full degree of variety potentially demanded will not be supplied because economies of scale exist in most industries. Scale economies mean that the potential welfare or revenue gain from greater variety must be balanced against the lower unit production costs with fewer variants. However, your teacher seems to imply that this effect is balanced by the economies of scope. This arises when the cost of performing multiple business functions simultaneously proves more efficient than performing each business function independently. But one possible ...

Solution Summary

Product line price line and quality model. Use of vertical differentiation to explain why there might be economies of scope in fixed costs, but firm still chooses to prodcue fewer than theee products.