Working Paper: CEPR ID: DP1455
Authors: Stefan Lutz
Abstract: This paper studies how the existence of a potential entrant influences an incumbent?s choice of quality in a model of vertical product differentiation and entry. Both firms face fixed set-up costs and quality-dependent costs of production, and compete on quality and price. With identical quality-dependent costs, the incumbent will always deter entry if possible, i.e. if fixed costs are high. Quality will be set at a level lower than the optimal quality set if entry was accommodated. If entry is not blockaded, quality will be set at a level strictly lower than the optimal quality set under monopoly.
Keywords: product differentiation; oligopoly; quality standards; entry
JEL Codes: L12; L13; L15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high fixed costs (G31) | decrease in quality (L15) |
| entry not blockaded (D74) | quality lower than monopoly optimal level (D43) |
| increase in entrant's fixed costs (L11) | weakly increase incumbent's gain from deterring entry (D43) |
| substantially lower quality-dependent costs for entrant (L15) | incumbent may prefer to accommodate entry and choose lower quality (L15) |
| ability of incumbent to deter entry depends on fixed costs, quality-dependent costs, and market size (L11) | deterrence strategy (L21) |