Amit Pazgal, David Soberman, and Raphael Thomadsen
Minimum Differentiation is the equilibrium in spatial models with fixed prices, while firms move apart to reduce the intensity of competition when firms set prices. Nevertheless, firms collocate in many industries where marketing-active firms compete on price. This puzzle is called the Hotelling paradox. We offer a resolution of this puzzle by noting that imperfect information about the availability of all products can soften competition, allowing firms to produce similar products without engaging in intense price competition. Specifically, we construct a model that predicts minimum differentiation when consumers have low awareness about products and maximum differentiation when they are well informed.