A note on the low‐quality advantage in vertical product differentiation

Abstract

In this paper, we modify the analysis of Schubert (2017), who found low‐quality advantage arising from vertical differentiation. Here, we relax the assumption of a sufficiently high reservation utility (so that consumers will always buy the good) to include the case in which they can refrain from buying the good. We find an explicit solution to profit functions, with the result that low‐quality advantage disappears.

Market configurations when marginal costs are quality‐dependent

“…In fact, the vast majority of the existing studies assume either partial market coverage (Aoki & Prusa, 1996; Benassi et al, 2006; Lambertini & Tampieri, 2012; Motta, 1993; Niem, 2019) or full market coverage (Crampes & Hollander, 1995; Garella & Lambertini, 2014; Schmidt, 2006; Schubert, 2017), hence disregarding the important fact that the market configuration is determined endogenously when firms choose their quality‐price combinations 1 . We use the term market configuration to capture both market structure (monopoly or duopoly) and market coverage (partial or full).…”

“…Regarding these costs, many of the initial VPD models assumed nil costs (Choi & Shin, 1992; Gabszewicz & Thisse, 1979; Tirole, 1988; Wauthy, 1996). Fixed or investment quality costs, such as R&D or advertising activities performed to improve quality, have been considered by authors such as Shaked and Sutton (1982), Lambertini (1999), Liao (2008), García‐Gallego and Georgantzís (2009), and Niem (2019). Marginal production costs increasing with quality, which happens when higher quality requires more expensive inputs, have been assumed by Mussa and Rosen (1978), Lambertini (1996), Schmidt (2006), Schubert (2017), and Pires et al (2022).…”

“…If one assumes that consumers' tastes are distributed on the interval [0, ], where is the highest quality valuation, the market is implicitly uncovered because the lowest valuation consumer is not willing to pay anything for quality. This assumption has been used in many papers, including Aoki and Prusa (1996), Lehman‐Grube (1997), Lambertini and Tedeschi (2007), and Niem (2019).…”