Essays on vertical product differentiation

Abstract

This dissertation explores models of heterogeneous product markets that rely on the product formulation, where products differ in their quality levels and consumers differ in their willingness to pay for quality. The demand structure applied here is the covered-market configuration under the vertical product differentiation. With this specification, product market equilibria of the monopoly and duopoly market are derived. In particular, parameter restrictions on the degree of relative consumer heterogeneity associated with the covered-market setting are identified and used to interpret analytical results. Based on the specified demand structure, I revisit two industrial organization topics from the perspectives of vertical product differentiation. The first essay analyzes the entry of a new product into a vertically differentiated market where an entrant and an incumbent compete in prices. Many models on strategic entry deterrence deal with quantities as the established firm's strategic tool to deter or accommodate entry. Here, however, the entry-deterrence strategies of the incumbent firm rely on qualities. With a sequential choice of quality, quality-dependent marginal production cost, and a fixed entry cost, I relate the entry-quality decision and the entrydeterrence strategies to the level of an entry cost and the degree of consumer heterogeneity. In particular, the incumbent influences the quality choice of the entrant by choosing its quality level before the entrant. This allows the incumbent to limit the entrant's entry decision and quality levels. Quality-dependent marginal production costs in the model entail the possibility of inferior-quality entry as well as the incumbent's aggressive entry-deterrence strategies by increasing its quality level towards potential entry. Welfare evaluation confirms that social welfare is not necessarily improved when entry is encouraged rather than deterred. The second essay is motivated by some specific economic questions that have arisen with the introduction of 'genetically modified' (GM) agricultural products. A duopoly market-entry model associated with the vertical product differentiation is developed to show how the existence of segregation costs biases the firm's quality choice behavior. Thus, the key factor of the model is the cost of segregation activities that are necessary to distinguish