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COMPETITION WITH PRICE-DEPENDENT PREFERENCES

In this paper, I develop a duopoly location model of differentiated products in which consumers’ product preferences vary positively with product prices. The level of preference price-dependence (“PPD”) is allowed to vary across consumers. I find that equilibrium prices increase with the PPD level of the marginal, or “just indifferent,” consumer, but are not influenced by the PPD levels of other consumers. The marginal consumer’s PPD increases the effect of exogenous product differentiation on price. When product differentiation is a choice variable of the firms, firms invest more in differentiating their products when the marginal consumer’s PPD level is higher.