Vertical Product Differentiation with Linear Pricing

This paper considers a monopolist that conducts vertical product differentiation. Previous analyses that assume customers have unit demand or firms conduct non-linear pricing. In contrast to these studies customers purchase multiple units at a linear price. Customers differ in their income and preferences, particularly their willingness to substitute between quantity and quality. The model distinguishes those aspects of customer demand that are sources of vertical differentiation (income and preferences) from those aspects that cause quality distortion. It is demonstrated that under uniform ordering vertical differentiation only causes quality distortion when consumer demand is such that there is a material difference in the mark-up of different varieties. Under non-uniform ordering a variety of patterns of quality distortion are possible.