Abstract
Using a product variety model, where higher-quality products increase consumer utility and quality products are more costly to produce, we show that optimal product quality depends on a parameter of the consumer utility function and the firm's cost of production. Our theoretical analysis shows that a firm's unobserved product quality is structurally linked to its observed sales revenue; the structural relationship allows estimation of the product quality within an industry. We then utilize firm-level data from China from 2005 to 2007 to estimate product quality in China's (i) food processing and (ii) food manufacturing industries. By comparing the distributions of product quality (and product quality growth rates) over time, we argue that product quality in both industries is improving.
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