Quality and Price Effects in a Vertically Differentiated Duopoly
with Marginal Cost Differentials
Abstract:
A vertically differentiated duopoly model analyzes the impact of marginal
cost differentials on price and quality. Firms play a two-stage game, first
simultaneously choosing quality and then simultaneously choosing price.
When the firm producing the high quality good faces an increase in its
marginal cost, both firms increase price and upgrade quality. When the
firm producing the low quality good faces an increase in its marginal cost,
both firms decrease price and downgrade quality. When a first firm enters
the market, quality position decisions are examined under the assumption
that both the firm-specific and the quality-specific marginal costs are
higher when a firm produces a higher quality good. The results show that
the first entrant produces the low quality good and earns higher profits.