9.1 Quality

Firms have two main dimensions of choice in determining the nature of the product: what level of quality to offer, and how much variety. Quality is something that all consumers want and agree upon (durability, safety, reliability, etc.) In contrast, variety is a matter of taste (i.e. color, form, etc.)

Quality under Competition and Monopoly

The key in analyzing quality is to distinguish between the product that is sold in the market and what the consumers are really interested in -- the underlying service. (i.e. ends and means, such as gasoline is an end to road mileage). The quality of a good is the service provided per physical unit (the umph). 
Suppose there are a fixed number N of competitive firms. The nth firm produced quantity q at a certain quality level, l. The representative firm's output of the service z can be written as
\(z_n \equiv \ell _n * q_n\)
If users are fully informed, the price of each firm's product will reflect its quality. Although consumers pay a direct dollar price P, what underlies that price is the price of the service, denoted as \(\mathbb{P} _n\). Therefore the prices of different brands much reflect the product quality offered:
\(P_n = \ell _n * \mathbb{P} _z\)
What determines the underlying price of the service? Under conditions of perfect competition, the answer, as usual, is supply and demand. The demand curve shows what consumers are willing to pay for amounts of service offered on the market. The supply curve shows the amounts of service that the firms are willing to provide at each price. 
Recall that competitive firms determine output by setting their Marginal Cost of the product equal to the market price. With this difference in quality, now each firm chooses the profit-maximizing amount of the service to offer:
\(\mathbb{P} _z = MC_z\)
Proposition: For any amount of service generated, the firm's quality and quantity choices are correctly balanced when the MC of expanding service by increasing quantity and the MC of expanding service by improving quality are equal. The true (lowest) MC of providing the service is the same as both these MCs when these are equal:
\(MC_z = MC _q = MC_\ell\)
The key point is that since consumers are really buying the underlying service, quality differences will be fully reflected in higher and lower prices. 
What about monopolies? We already know that they provide a smaller quantity of a product than a competitive industry. Is there reason for it to offer lower quality as well?
The monopolist will set its MC equal to its MR, both now defined in terms of service:
\(MC_z = MR_z\)
The answer is that changes in service output are best achieved by balanced adjustments of both quantity and quality. Therefore, the smaller service output of a monopoly will also involve some combination of reduced quantity and lower quality. 
What about innovation? What about cartels? If consumers are fully informed, a quality-improving innovation is equivalent to a cost-reducing innovation. Neither would be suppressed by a profit-maximizing monopolist. Normally, consumers also gain. Cartels would now have to control cheating in two directions -- quantity and quality. An example of this was when airlines fixed their international prices. The airlines were allowed to provide sandwiches, which eventually became the margin on which they increased, leading to sumptuous meals. 

9.2  Variety

How do product markets respond to variations in consumer tastes or needs? Many aspects will arise in various combinations to meet consumer's demand. An application of this has been religion. Countries with low variance of religion have been found to exhibit extremely low levels of church attendance, vs. countries like the US that offer myriads of religions and have relatively high attendance. These variations fit consumers' preferences. 

Product Variety under Monopoly

The monopolist addresses three problems: how many varieties to produce, how much of each, and what prices for each. As before, the monopolist will produce wherever the TR curves is maximized above the TC curves.  
Under monopolistic competition, aggregate output is greater and price is lower than under multiplant monopoly. But the number of independent firms under monopolistic competition, each offering their own unique variety, could be either larger or smaller than the profit-maximizing number of varieties offered by the monopolist producer. Thus though consumers benefit from a lower price, they may or may not enjoy a better assortment of varieties.