Product Differentiation by Package Size Sanatan Shreay Gilead Sciences, Foster City, California. E-mail: sshreay@gmail.com Hayley H. Chouinard School of Economic Sciences Washington State University, Pullman, Washington. E-mail: chouinard@wsu.edu Jill J. McCluskey School of Economic Sciences, Washington State University, Pullman, Washington. E-mail: mccluskey@wsu.edu ABSTRACT Quantity surcharges exist when a larger-sized package has a higher per-unit price than its smaller-sized counterpart. This article argues that quantity surcharges can be explained by the fact that different sizes of the same product are imperfect substitutes and thus are differentiated products. To test this hypothesis, we utilize grocery store scanner data to estimate a demand system and the associated cross-price elasticities. We focus our empirical investigation on canned tuna, which often exhibits quantity surcharges. A random coefficients logit demand approach is used to calculate elasticities. There is evidence to support the hypothesis that quantity surcharges in canned tuna are driven by firms catering to heterogeneous consumer preferences. [EconLit citations: L25; L66]. C  2015 Wiley Periodicals, Inc. 1. INTRODUCTION Consumers often have strong expectations about the relative prices of products found in different sized packages. Quantity discounts occur when the price per unit of a brand’s larger-sized package is less than the price per unit of the same brand’s smaller-sized package. In contrast, quantity surcharges exist when a larger-sized package of a product has a higher per unit price then its otherwise equivalent smaller-sized counterpart. Most studies find evidence of quantity surcharges, with the size of the surcharges ranging from 7% to 34% (Abdulai, Kuhlgatz, & Schmitz, 2009). Many researchers compare per-unit prices of products to examine nonlinear pricing, specifically looking for quantity surcharges (Granger and Billson, 1972; Nason & Della Bitta, 1983; Manning, Sprott, & Miyazaki, 2003; Abdulai et al., 2009). Consumers often react negatively to quantity surcharges. Previous research finds that when consumers discover quantity surcharges, they often feel that the retailer has engaged in deceptive pricing practices or has eliminated a preferred course of action (e.g., purchasing the larger package) for the consumer and this may decrease the likelihood of purchasing the surcharged brand or shopping in that retail outlet (Manning, Sprott, & Miyazaki, 2003). Consumers may feel exploited as they begin to associate a brand or store with quantity surcharges (Widrick, 1979). Cost differentials have been offered as justification for differences in per-unit prices across homogeneous products. Examining quantity for paper towels, Cohen (2008) estimates a struc- tural model of consumer behavior and firm conduct to decompose the extent to which quantity discounts are consistent with second-degree price discrimination as opposed to cost differ- ences across package sizes. A cost-based argument is harder to make for the case of quantity surcharges. For some perishable food products, it may be more expensive to refrigerate larger packages of some goods, which can drive cost-based quantity surcharges. In the marketing literature, some suggest that retailers may be exploiting consumers who do not notice quantity surcharges (Agrawal, Grimm, & Srinivasan, 1993; Gupta & Rominger, 1996). Alternatively, retailers may not intentionally set prices that result in quantity surcharges. These retailers may actively compete with other retailers on specific sizes of fast-moving items Agribusiness, Vol. 0 (0) 1–13 (2015) C  2015 Wiley Periodicals, Inc. Published online in Wiley Online Library (wileyonlinelibrary.com/journal/agr). DOI: 10.1002/agr.21425 1