The Effects of Product Bundling in Duopoly

This paper studies the incentives for multiproduct duopolists to
sell their products as a bundle. It is shown that contrary to the
monopoly case bundling may reduce profits and increase consumer
rent. This is the case if consumers' reservation values are
negatively correlated. The reason is that bundling reduces consumer
heterogeneity and makes price competition more aggressive. This
effect can dominate the sorting effect that is well known for the
monopoly case. Firms are in a prisoner's dilemma situation because
they would be better off without bundling. Despite the lower prices
a welfare loss occurs because some consumers do not buy their
prefered product which results in distributive inefficiency. If
firms can influence the correlation by choosing their location in
the product range they try to avoid negative correlation and choose
minimal differentiation in one good.