Brand-Specic Tastes for Quality

This paper develops a model of nonlinear pricing with competition. The novel element is that each consumer’s willingness to pay for quality is private information and is allowed to di¤er across brands. The consumer’s preferences are represented by a multidimensional type containing the marginal value of quality for di¤erent products. Buyers with high willingness to pay for quality also display strong preferences for particular brands, and require higher discounts in order to switch away from their favorite product. Therefore, competition is …ercer for buyers with lower tastes for quality, and hence more elastic demands. This is in sharp contrast to earlier models in which competition is …ercer for higher-taste, more valuable buyers. In equilibrium, …rms either compete intensively for the entire market (providing strictly positive rents to all consumers) or shut down the least pro…table segment of the market. Quality levels are distorted downwards for all buyers, except for those with the highest type. The number of competing …rms and the degree of correlation across brand preferences enhance the e¢ ciency of the allocation. Keywords: Nonlinear pricing, multidimensional types, oligopoly, menus of contracts, product di¤erentiation. JEL Classification: D43, D86, L13 MIT Sloan School of Management, 100 Main Street, Cambridge MA 02142. bonatti@mit:edu. This paper is based on Chapter 2 of my doctoral dissertation at Yale University. I am indebted to Dirk Bergemann and Ben Polak for their invaluable help and encouragement throughout this project. This paper bene…ted from comments by Rossella Argenziano, Mark Armstrong, Luigi Balletta, Dino Gerardi, Michael Grubb, Jean-Charles Rochet, Maher Said, Dick Schmalensee, and participants in the 2007 North American Summer Meeting of the Econometric Society and in the Micro Theory Lunch at Yale University. Finally, I wish to thank Bernard Caillaud and two anonymous referees whose comments helped improve both the analysis and the exposition of the paper.