DP7187 Functional Differentiation
Models of product differentiation typically assume a demand for variety. This paper derives the demand for variety in a model where a representative consumer chooses how many specialised varieties to purchase for the pursuit of different activities. In contrast with previous models this generates a demand for variety that is price and income elastic. In applications to monopoly and duopoly I find that whilst a duopoly will choose efficient characteristics it will offer too many specialised varieties, whereas a monopoly will either offer excessively specialised varieties or too few specialised varieties on the assumption of no fixed costs of variety.