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T he I nteractive E ffect of P roduct D ifferentiation and C ost V ariability on P rofit
Author(s) -
Chang MyongHun,
Harrington Joseph E.
Publication year - 1996
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/j.1430-9134.1996.00175.x
Subject(s) - product differentiation , profit (economics) , economics , microeconomics , shock (circulatory) , monetary economics , cost reduction , industrial organization , competition (biology) , product proliferation , new product development , medicine , ecology , management , cournot competition , biology , product management
It is generally believed that industries with greater product differentiation have higher rates of return. This paper shows that this effect breaks down in the presence of firm‐specific cost shocks. Greater substitutability in products generates two opposing effects: (1) it allows a larger increase in demand when a firm has a favorable cost shock, which more than compensates for the reduction in demand when it has an unfavorable cost shock, and (2) it results in more intense price competition. These two countervailing forces result in industry profit being highest in markets with a moderate degree of product differentiation.