Location choices and third‐degree spatial price discrimination

Date01 May 2018
Published date01 May 2018
Hong Feng* and Jie Ma**
This paper studies how firms choose their product differentiation levels when they
engage in third-degree price discrimination in the following product market compe-
tition in a location-price model. We show that firms will not choose to locate at the
two endpoints if different consumer groups have similar sizes. Hence, the principle
of maximum differentiation does not hold, resulting in a more intense product mar-
ket price competition. Only if the size of one group of consumers is sufficiently lar-
ger than that of the other group, would firms make their products as differentiated
as possible by choosing the two endpoints as their locations.
Third-degree price discrimination, that is, firms charge different prices to dif-
ferent groups of consumers, is the most common type of price discrimination
in the real world. For instance, car makers, such as Mercedes-Benz, BMW
and Audi, have different pricing strategies in the United States and China; air-
lines offer discounts to child travellers; and so on. It is natural to think that
firms will take the opportunity of conducting third-degree price discrimination
into account when they design their products. In general, they will not choose
to locate at the same place in the product space in order to avoid drastic price
cuts. However, how and to what extent do firms differentiate their products
from each other when they subsequently compete for market shares in each
consumer group? It is the question that we try to study in this paper.
We consider a model
alaHotelling where in a linear city two firms play a
two-period location-price game of complete information. Based on some
exogenous information about consumers, the two firms can divide them into
two segments.
In the first period, two firms simultaneously and
*Harbin Institute of Technology (Shenzhen)
**University of International Business and Economics (UIBE)
Note that there are different ways to obtain consumers’ information in order to divide
them into different groups. For instance, some characteristics of consumers, for example,
location, age and sex can be easily identified. Alternatively, firms can purchase relevant infor-
mation from a third party. (See, e.g., Liu and Serfes (2004).)
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12165, Vol. 65, No. 2, May 2018
©2018 Scottish Economic Society.

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