Market Segmentation, Self-Selection, and Product Line Design

The purpose of this paper is to develop a theory of market segmentation based on consumer self-selection. The extant theory is based on the third-degree price discrimination model of Pigou, central assumptions of which are that the firm can directly address individual segments and isolate them. By using consumer self-selection, I am relaxing these assumptions. In the context of a monopolist designing a product line, I show that this relaxation has significant implications for how the products and prices are chosen and what they look like. In particular, segments may be aggregated even though there are no economies of scale. Furthermore, consumer self-selection enables us to model “cannibalization” and competition among firms.