Exchange Rates and Product Variety

We study the role of exchange rate variability in the firm’s choice of whether to o¤er one or two varieties. We show that variability induces the firm to vertically segment markets (offer two varieties). This happens because variability in the exchange rate a¤ects income dispersion and hence the firm’s incentives to extract consumer surplus. To better extract surplus, the firm offers two price-quality menus, a high quality variant geared for top-end surplus extraction and a low quality variant to address market coverage concerns.