Working Paper: CEPR ID: DP9810
Authors: Kurt Richard Brekke; Luigi Siciliani; Odd Rune Straume
Abstract: In a spatial competition setting there is usually a non-negative relationship between competition and quality. In this paper we offer a novel mechanism whereby competition leads to lower quality. This mechanism relies on two key assumptions, namely that the providers are motivated and risk-averse. We show that the negative relationship between competition and quality is robust to any given number of fims in the market and whether quality and price decisions are simultaneous or sequential. We also show that competition may improve social welfare despite the adverse effect on quality. Our proposed mechanism can help explain empirical findings of a negative effect of competition on quality in markets such as health care, long-term care, and higher education.
Keywords: motivated providers; quality; price competition; risk-averse providers
JEL Codes: D21; D43; L13; L30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased competition (L13) | Reduction in quality (L15) |
| Lower transportation costs (L91) | Increased competition (L13) |
| Reduction in profits (D33) | Negative marginal utility from profits (D11) |
| Negative marginal utility from profits (D11) | Lower quality (L15) |
| Increased competition (L13) | Lower prices (D49) |
| Lower prices (D49) | Reduction in profits (D33) |