Pre-emption, Predation, and Minimum Quality Standards

Abstract

We present a model of vertical product differentiation and exit where a domestic and a foreign firm face fixed setup costs and quality-dependent costs of production and compete in quality and price in the domestic market. Quality-dependent costs are quadratic in qualities, but independent of the quantities produced. The domestic government may impose a minimum quality standard binding for both foreign and domestic firms. In the presence of an initial cost advantage of the domestic firm, a sufficiently high minimum quality standard set by the domestic government will enable the domestic firm to induce exit of the foreign firm, i.e. to engage in predation. However, the same standard would lead to predation by the foreign firm, if the foreign firm had the initial cost advantage!