International Pricing in a Generalized Model of Ideal Variety

Abstract

We examine international markups and pricing in a generalized version of an “ideal variety” model. In this model, entry causes crowding in variety space, so that the marginal utility of new varieties falls as market size grows. Crowding is partially offset by income effects, as richer consumers will pay more for varieties closer matched to their ideal types. We show theoretically and confirm empirically that declining marginal utility of new varieties results in: a higher own‐price elasticity of demand (and lower prices) in large countries and a lower own‐price elasticity of demand (and higher prices) in rich countries. The model is also useful for generating facts from the literature regarding cross‐country differences in the rate of variety expansion.