Working Paper: NBER ID: w9675
Authors: Steven Berry; Joel Waldfogel
Abstract: Recent literature notes that when quality is produced with fixed costs, a high quality firm can undercut its rival's prices and may find it profitable to invest more in quality as market size grows large. As a result, a market can remain concentrated even as it grows large. When quality is produced with variable costs, by contrast, a wide range of product qualities can coexist in the market because they are offered at different prices. Larger markets will fragment and offer products with a wider range of qualities. Using US urban areas as markets, we examine the relationships between market size and product quality - and between market size and product concentration - for two industries that differ in their quality production process. We document that in the restaurants industry, where quality is produced largely with variable costs, the range of qualities on offer increases in market size, with each product maintaining a small market share. In daily newspapers, where quality is produced with fixed costs, the average quality of products increases with market size, and the market does not fragment as it grows large.
Keywords: No keywords provided
JEL Codes: L1; R3; L8
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market Size (L25) | Range of Product Qualities in Restaurant Industry (L15) |
| Market Size (L25) | Average Quality of Newspapers (L15) |
| Variable Costs (D24) | Range of Product Qualities in Restaurant Industry (L15) |
| Fixed Costs (D24) | Average Quality of Newspapers (L15) |