Quality and Quantity Competition

Abstract

* Economists are becoming increasingly aware of nonprice competition under various market structures. While the well-developed theory about price and quantity competition is already at our disposal, a comparably well-developed theory of the qualitative attributes of products that consumers value does not exist. Product reliability, durability, and availability of service facilities are some examples of those attributes. The main objective of this article is to investigate the impact of increased competition on the quality levels and on the prices of the products when firms can choose both the quantity and the quality of their products. For this purpose we develop an oligopoly model and conduct a comparative statics analysis to investigate how a change in the number of firms affects the strategies chosen at the symmetric Nash equilibrium. Our model may be regarded as a generalization of the monopoly model developed by Mussa and Rosen (1978). In an earlier article by Gabszewicz and Thisse (1980) (G-T) a similar question, namely the impact of entry into a differentiated industry (where products of different quality are produced), is investigated. In their article, however, the type of the product produced by the firm is exogenously given: Some firms produce products of high quality and others produce products of low quality, even though the unit cost of producing either type of product is the same (zero in the example considered in the article). In contrast, in our model firms are free to choose the quality of the products they provide. Moreover, each firm may offer more than one type of product and simultaneously produce products of both low and high quality. The unit cost of production is assumed to rise when products of higher quality are produced. A single firm may diversify its production process into a spectrum of products of different quality, since it does not incur any additional fixed costs due to the diversification. If the production of each quality involved a different production facility and some initial fixed cost, no firm would ever find it optimal to diversify. The motivation for offering high quality products in our model is not the build-up of one's reputation (as in the dynamic model of Shapiro (1982)). Rather each firm offers products of various quality to segment the market and employs partial price discrimination.