How does firms' cost structure affect their quality-price mix? An experimental analysis

43 Pages Posted: 20 Jan 2022 Last revised: 5 Dec 2022

See all articles by Adriana Alventosa

Adriana Alventosa

Faculty of Economics. University of Valencia

Sílvia Jorge

GOVCOPP, DEGEIT, Universidade de Aveiro

Joana Pinho

Catholic University of Portugal (UCP) - Católica Porto Business School

Margarida Catalão‐Lopes

CEG-IST, Instituto Superior Técnico, Universidade de Lisboa

Cesaltina Pires

Universidade de Évora

Date Written: January 20, 2020

Abstract

Experimental literature on product differentiation is scarce and mostly focused on horizontal product differentiation. This paper focuses on vertical product differentiation considering a quality-then-pricing duopoly game and exploring how firms’ cost structure affects firms’ decisions and market structure. Two scenarios are considered, differing in the way quality affects production costs: in the first, quality is costless, while, in the second, marginal production costs increase with quality. We explore the impacts on market coverage, qualities, product differentiation, prices, and intensity of competition (assessed by price-cost margins). Our experimental results confirm the (theoretically proved) need to endogenize the market structure, as a duopoly with full coverage emerges when quality is costless, but a duopoly with partial coverage emerges when quality is costly. We also find that quality differentiation is lower in the lab than what is theoretically predicted, and lower in the costless quality treatment. The intensity of competition is higher when quality is costly, as price-cost margins are lower in this case.

Keywords: Vertical product differentiation, Quality-price game, Cost structures, Experimental economics C91

JEL Classification: C91, D21, L22

Suggested Citation

Alventosa, Adriana and Jorge, Sílvia and Pinho, Joana and Catalão‐Lopes, Margarida and Pires, Cesaltina, How does firms' cost structure affect their quality-price mix? An experimental analysis (January 20, 2020). Available at SSRN: https://ssrn.com/abstract=4012695 or http://dx.doi.org/10.2139/ssrn.4012695

Adriana Alventosa

Faculty of Economics. University of Valencia ( email )

Avda Tarongers s/n 46071
Valencia, Valencia 46023
Spain

Sílvia Jorge

GOVCOPP, DEGEIT, Universidade de Aveiro ( email )

Portugal

Joana Pinho (Contact Author)

Catholic University of Portugal (UCP) - Católica Porto Business School ( email )

Rua de Diogo Botelho 1327
Porto, Porto 4169-005
Portugal

Margarida Catalão‐Lopes

CEG-IST, Instituto Superior Técnico, Universidade de Lisboa ( email )

Av. Rovisco Pais 1, 1049-001
Lisbon
Portugal

Cesaltina Pires

Universidade de Évora ( email )

R. Romão Ramalho 59
Évora, 7000-671
Portugal

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