Characteristics Design: A Hedonic Approach to Optimal Product Differentiation

TL;DR

This paper analyzes optimal product differentiation using a hedonic model, revealing that monopolies align with social optima, while oligopolies often under-differentiate, leading to welfare losses that can be mitigated by common ownership.

Contribution

It provides a theoretical framework for understanding how product differentiation impacts welfare under different market structures, extending to ownership considerations.

Findings

Monopolist's choices align with social optimum despite underproduction.

Oligopoly equilibria show less differentiation than socially optimal levels.

Common ownership can enhance welfare by promoting differentiation.

Abstract

Building on the generalized hedonic-linear model of Pellegrino (2025), this paper studies optimal product differentiation when a representative consumer has preferences over product characteristics. Under multiproduct monopoly, the monopolist's choice of product characteristics is always aligned with the social planner's optimum, despite underproduction. By contrast, under oligopoly, multiple equilibria can arise that differ qualitatively in their patterns of characteristics design. We show that, while oligopoly equilibria exhibiting product differentiation yield higher welfare than those with product concentration, the degree of product differentiation under oligopoly remains below the socially optimal level. As a result, social welfare under oligopoly is typically lower than under monopoly, highlighting a key advantage of coordination in characteristics design. We extend the analysis to settings with overlapping ownership structures and show that common ownership can improve welfare by inducing firms to soften competition through increased product differentiation rather than output reduction.