On ethical product differentiation

Abstract

In our model of ethical product differentiation two duopolists compete over prices and (costly) "socially and environmentally responsible" features of their products. We show that the incumbent finds it optimal to reduce the price after the ethical producer's entry when his (non ethical) location is fixed. His optimal price is halfway between his zero profit price and the zero profit price of the ethical producer. By removing the fixed location hypothesis we find that the ethical producer’s entry has positive indirect effects on aggregate social and environmental responsibility since the incumbent finds it optimal to imitate him when consumers’ perception of ethical costs is sufficiently high. In the paper we also show that the solution of the three-stage game - in which location and prices are simultaneously chosen and the profit maximising producer is Stackelberg leader in location – has three main features: minimum price differentiation, ethical imitation and non minimal ethical differentiation. We explain the differences between these findings and those from a traditional Hotelling game as depending from three main features: 1) the different goals of the two (profit maximising and zero profit) competitors; 2) the asymmetric costs of "ethical" distance and 3) the lack of independence between ethical location and prices