DP1793 | Strategic Quality Choice with Minimum Quality Standards

Publication Date

31/01/1998

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Abstract

In many markets governments set minimum quality standards while some sellers choose to compete on the basis of quality by exceeding them. Such ?high-quality? strategies often win public acclaim, especially when ?environmental friendliness? is the dimension along which firms are differentiated. We analyse this phenomenon using a duopoly model of vertical product differentiation. A minimum quality standard leads both the high-quality and the low-quality firm to increase product qualities, lower prices, and increase quantities sold. As a result, total welfare increases. Industry profits fall, however, because reduced quality differentiation intensifies price competition. If the high-quality firm can commit to a quality level before regulations are promulgated, it induces the regulator to weaken its standards, and welfare falls.