On the microeconomic foundations of linear demand for differentiated products

Event Date: 21 March 2016

Location: Strathclyde Business School, Cathedral Wing, CW404b

Time: 4.15pm

Speaker: Rabah Amir, Iowa University

This joint paper with Philip Erickson and Jim Jin provides a thorough exploration of the microeconomic foundations for the multivariate linear demand function for differentiated products that is widely used in industrial organization. A key finding is that strict concavity of the quadratic utility function is critical for the demand system to be well defined. Otherwise, the true demand function may be quite complex: Multi-valued, non-linear and income-dependent. The solution of the first order conditions for the consumer problem, which we call a local demand function, may have quite pathological properties. We uncover failures of duality relationships between substitute products and complementary products, as well as the incompatibility between high levels of complementarity and concavity. The two-good case emerges as a special case with strong but non-robust properties. A key implication is that all conclusions derived via the use of linear demand that does not satisfy the law of Demand ought to be regarded with some suspicion.

Published: 8 March 2016