Industrial Technology Boundary, Product Quality Choice, and Market Segmentation

Abstract

Abstract This paper studies how firms in a duopoly market choose product qualities when facing two types of consumers: high-end consumers value quality more than low-end consumers. Firms’ highest possible quality (referred to as industrial technology boundary) is determined by an industrial common technology. I consider price competition and show that in equilibrium, an increase in the technology boundary can induce a decrease in the equilibrium quality of one firm. In this case, the firms enlarge their quality difference, triggering a market segmentation. In this market segmentation, the firm with a lower quality does not serve the high-end consumers and obtains higher profits from the low-end consumers, whereas the firm with a higher quality supplies both types of consumers and obtains higher profits as well. This market segmentation causes additional mismatch costs for high-end consumers, therefore lowering both consumer and social surplus.