Spatial Competition in Quality

55 Pages Posted: 25 Sep 2014

See all articles by Raphael Auer

Raphael Auer

Swiss National Bank; Bank for International Settlements (BIS)

Philip U. Sauré

Johannes Gutenberg University Mainz - Gutenberg School of Management and Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 2014

Abstract

We develop a model of vertical innovation in which firms incur a market entry cost and position themselves in the quality space. Once established, firms compete monopolistically, selling to consumers with heterogeneous tastes for quality. We establish existence and uniqueness of the pricing game in such vertically differentiated markets with a potentially large number of active firms. Turning to firms' entry decisions, exogenously growing productivities induce firms to enter the market sequentially at the top end of the quality spectrum. We spell out the conditions under which the entry problem is replicated over time so that each new entrant improves incumbent qualities in fixed proportions. Sequential market entry overcomes the asymmetry of the location problem, which unavoidably arises in the quality spectrum because of its top and bottom ends. Our main technical contribution lies in handling this asymmetry, a feature absent in Salop (1979) and other circular representations of Hotelling (1929) and Lancaster (1966).

Keywords: 15/6

JEL Classification: D4, L11, L13

Suggested Citation

Auer, Raphael and Sauré, Philip U., Spatial Competition in Quality (June 2014). CEPR Discussion Paper No. DP10027, Available at SSRN: https://ssrn.com/abstract=2501499

Raphael Auer (Contact Author)

Swiss National Bank ( email )

Fraumuensterstr. 8
Zurich, 8022
Switzerland

Bank for International Settlements (BIS)

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Philip U. Sauré

Johannes Gutenberg University Mainz - Gutenberg School of Management and Economics ( email )

Germany

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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