Vertical Product Differentiation When Quality is Scarce: The Case of n > 2 Firms

Mark R. Frascatore

Australian Economic Papers, 1999, vol. 38, issue 2, 120-130

Abstract: This paper describes a model of vertical product differentiation in which more than two firms compete in quality and price. Quality is of fixed supply, so firms participate in an auction to attain it. Firms then simultaneously choose prices. The paper determines equilibrium bids in the quality auction and the Bertrand equilibrium prices. In equilibrium one firm attains all the units of quality, but pays a price such that it, like the minimum‐quality firms, earns zero profits. Aggregate welfare is computed, and is shown to decrease as competition increases.

Date: 1999
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