Location and Product Choice in Option Demand Markets

Consumers’uncertainty regarding their future needs generates demand for options to utilize different products. Such options are commonly sold in the form of insurance. A prime example for option demand presents in health care markets and other repair markets. This work studies two-dimensional spatial competition between medical providers who choose their geographical location and medical-care specialization (i.e. product differentiation). Consumers know their geographical address but do not know their preferred medical treatment before getting sick. Providers make location and product choices and then compete by selling options to utilize their services (i.e. health insurance). I characterize two types of equilibria: one with Min-Min differentiation that is complete assimilation and the other with Min-Intermediate differentiation, in which both providers locate at the city center and product differentiation is effi cient. In the first equilibrium each consumer buys insurance for one provider only and in the second all consumers are buying insurance for both providers. I further show that under regulated locations product differentiation first increases with regulated geographic distance and then it decreases. For intermediate regulated distance consumers who reside around the city center buy insurance for both providers and those at the city ends buy insurance only for the nearby provider. JEL Classification: : I11, I13, L1 Key-words: Location, Product Differentiation, Option Demand ∗Economics Department Auburn University , Auburn AL. Email: [email protected] . Tel: 716-867-9497.