Scale economy and self-selection problem

Abstract

We consider a monopolist``s problem of designing and pricing a product line of goods of different qualities. Consumers vary in their evaluations of quality, so that the well known self-selection problem arises. The main purpose is to incorporate economies of scale into the picture and examine how this new element affects the existing results. Specifically, we show that the relative size of quality, as is so in the theory of ordinary monopolistic quantity choice, is determined by the interaction of both consumers`` preferences and firm``s cost structure. With this structure, we also characterize the distortions inherent in the sorting process and find the sufficient conditions for market separations.