Fixed Costs, Product Variety, and Welfare on the Internet

The impact of product variety on welfare has received little attention in the electronic commerce literature. The problem with product variety is that more variety does not necessarily imply higher welfare. This paper finds the conditions under which more variety, if caused by lower fixed costs, implies an unambiguous welfare gain. A calibration to the market of books confirms the intuition that fixed costs –in particular, per-title fixed costs–are much lower at online stores than at conventional stores and that the welfare gains from electronic commerce are likely to be underestimated if one ignores changes in product variety.