Dynamic Entry in Vertically Differentiated Markets

50 Pages Posted: 29 Nov 2016

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: October 18, 2016

Abstract

We develop a model of vertical innovation in which firms incur a market entry cost and choose a unique level of quality. Once established, firms compete for market shares, selling to consumers with heterogeneous tastes for quality. The equilibrium of the pricing game exists and is unique within our setup. Exogenous productivity growth induces firms to enter the market sequentially at the top end of the quality spectrum. A central feature of the model is that optimization problems of consecutive entrants are self-similar so that new firms enter in constant time-intervals and choose qualities that are a constant fraction higher than incumbent qualities. The asymmetries of quality choice, which inevitably arise because the quality spectrum has top and a bottom, is thus overcome by sequential entry. Our main contribution lies in handling these asymmetries.

Keywords: vertical differentiation, product quality, non-homogenous preferences, natural monopoly, endogenous growth, quality ladders

JEL Classification: A110, D430, L110, L130, O400

Suggested Citation

Auer, Raphael and Sauré, Philip U., Dynamic Entry in Vertically Differentiated Markets (October 18, 2016). CESifo Working Paper Series No. 6130, Available at SSRN: https://ssrn.com/abstract=2876535 or http://dx.doi.org/10.2139/ssrn.2876535

Raphael Auer

Swiss National Bank ( email )

Fraumuensterstr. 8
Zurich, 8022
Switzerland

Bank for International Settlements (BIS)

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Philip U. Sauré (Contact Author)

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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