Hotelling Model of Product Quality Differentiation

customer value,

V

x

0.01

0.9

median consumer location, x

0.01

0.6

product A position, a

0.01

0.3

product B position, b

0.01

0.8

linear transport tariff

0.01

1

maximum prices of products A and B

{

P

a

=

0.60

,

P

b

=

0.70

}

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equilibrium

equal prices

Consider a linear Hotelling model of product differentiation in terms of quality. It is straightforward to model any differentiation as a continuum of all possible qualities between 0 and 1. This interpretation of the original Hotelling location model (1929) is typical of the industrial organization branch of economic theory that studies market structure and competition.

This model has a high degree of generality and can be extended to other areas. For example, in political science, with some minor modifications, it is interpreted as the "median voter" model of competition between two political parties.