Quality Choice, Fixed Costs and Equilibrium in Models of Vertical Differentiation

Abstract

I provide a full characterization of the quality choice in duopolies with vertical differentiation, without assuming ex-ante if the market is fully covered or not. This will allow to show that covered or uncovered market configurations are endogenous outcomes of firms’ strategic interaction. To this purpose, I assume that firms are characterized by quadratic fixed costs of quality improvements and check whether pure-strategy subgame perfect equilibria with a corner solution always exist. Finally, my results are compared to the quality choice that maximizes the total surplus of the economy. I show that the welfare-maximizing choice of qualities does not have to be found in the same market configuration of the corresponding market equilibrium.

Keywords: quality, oligopoly, vertical differentiation, market configuration, subgame perfect equilibrium, welfare analysis.

JEL Classification: L12, L15, L82, L86