Vertical Differentiation Model Research Articles

Competing to Sell the Reference Product

AbstractIn a sequential model of vertical product differentiation in which consumers are loss-averse, I analyse how firms compete to sell the reference product when they set prices. I find that there are two subgame perfect equilibria: one where the reference point for all consumers is the higher-quality product; and the other where the reference point is the lower-quality product. However, applying the risk-dominance criterion, I obtain that the sole risk-dominant equilibrium is for the higher-quality firm to sell the reference product. Since the hedonic price of the higher-quality product is the highest, consumers do not suffer any psychological disutility in the risk-dominant equilibrium.

Impact of Consumer Data Value on Pricing of Platform Enterprise

Based on the background of digital economy, this paper mainly discusses the value of consumer data and the promotion effect of digital finance on enterprise entre-preneurship, and analyzes the differentiated choice of pricing strategy for platform enterprises under the situation that consumer data is known and unknown. Based on the linear city model, circular city model and vertical differentiation model, this paper constructs the competition system of platform enterprises in two situations: consumer data is known and consumer data is unknown, and reveals the influence of consumer data on the pricing strategy of platform enterprises. The research shows that consumer data can influence the pricing strategy of platform enterpris-es, and when consumer data is unknown to platform enterprises, they tend to choose unified pricing. At this time, consumers choose service types based on their preferences. If consumer data is known to platform enterprises, platform enter-prises will choose personalized pricing in order to compete with consumers in the market, but the price will be low, which will increase consumer welfare at the mi-cro level. Moreover, the development of digital finance based on the background of digital economy has a positive role in promoting new enterprises and affecting consumer welfare at the macro level, it has practical significance and profound re-search significance for the study of social welfare changes.

Close But Not Too Close? Optimal Copycat Strategies in the Light of Negative Publicity by the Original Product

Abstract This paper contributes to the understanding of how brand scandals related to a brand leader’s product affect the follower firm’s choice between copycatting and independent product development. In a model of vertical product differentiation, we show that it is optimal for the copycatter to follow a ‘safe distance’ strategy which guarantees a certain degree of protection against the negative spillovers associated with a brand scandal to the leader. Nevertheless, when the follower firm can choose between copycatting and decoupling, it chooses a higher quality for its copycat product because of the lower development costs. The decision for or against copycatting thus depends on a trade-off between development costs and the possibility of negative spillovers. Finally, we show that the threat of a scandal can lead to an additional indirect welfare cost because it diverts the follower’s choice away from a welfare-maximizing copycat strategy.

Market for artificial intelligence in health care and compensation for medical errors

We study the market for AI systems that are used to help to diagnose and treat diseases, reducing the risk of medical error. Based on a two-firm vertical product differentiation model, we examine how, in the event of patient harm, the amount of the compensation payment, and the division of this compensation between physicians and AI system producers affects both price competition between firms, and the accuracy (quality) of AI systems. One producer sells products with the best-available accuracy. The other sells a system with strictly lower accuracy at a lower price. Specifically, we show that both producers enjoy a positive market share, so long as some patients are diagnosed by physicians who do not use an AI system. Any transfer in compensation payment from the physician to the AI producer in the case of a diagnostic error will be passed on in full to the physician via the price of the AI system. The quality of the AI diagnosis system is independent of how any compensation payment to the patient is divided between physicians and producers. However, the magnitude of the compensation payment matters. An increase in compensation increases demand for both AI systems. In addition, the higher the compensation paid to the harmed patient, the higher the quality of the low-quality AI system. As the other firm continues to offer the highest accuracy level, any increase in compensation will decrease vertical differentiation, thereby increasing price competition between firms.

Dumping, antidumping duties, and price undertakings

This paper examines which types of firms, from a developed country (DC) or a less developed country (LDC), tend to practice dumping, using a two-market equilibrium analysis of trade in similar products. Specifically, we present a vertical product differentiation model of duopolistic competition between a DC firm and an LDC firm under free trade to show that the DC firm sells a higher-quality product without dumping. In contrast, the LDC firm sells a lower-quality product and practices dumping in the DC market by charging a price lower than the product's price in the LDC's local market. In response to the LDC dumping, the DC government's use of an optimal antidumping duty increases its domestic welfare. The LDC's social welfare may increase if its exporting firm accepts price undertaking rather than dumping. From the perspective of world welfare, defined by aggregating the welfare of the trading countries (DC and LDC), the trade damage measure through imposing antidumping fines on LDC dumping is Pareto-improving compared to free trade (under which dumping takes place) and price undertakings.

Research on Service-Driven Benign Market with Platform Subsidy Strategy

The benign consumption of two-sided markets and the quality improvement of the supply side is the core of the sustainable development of platform ecology. This paper discusses how the platform uses personalized service values to influence the decision making of manufacturers and consumers, thus improving the health development of the platform ecosystem. By constructing the vertical differentiation model, we find that, different from the unified pricing strategy in the benchmark market, manufacturers in the platform market can implement personalized pricing, according to the different types of consumers’ quality preferences. When the platform service value is less than the product cost difference between manufacturers, low-quality manufacturers may benefit from the platform. Meanwhile, when the platform service value is greater than the product cost difference between manufacturers, the lemon market may appear and platforms should set the differentiated subsidy strategy according to the type of market consumers; this is a dominant strategy. In addition, when the number of consumers with low-quality demand in the market is large, the platform’s subsidies for high-quality products to consumers will guide consumers to buy high-quality products; this will not only promote the development of the benign market, but also improve the platform’s revenue. Finally, the sensitivity analysis shows that the platform service value has a U-shaped impact on the platform revenue and an inverted U-shaped impact on the manufacturers’ revenues.

Combating deceptive counterfeiting in digital supply chain

PurposeProduct counterfeiting has been ubiquitously observed in various segments of the supply chain. The intrinsic values of brands create more opportunities for counterfeiting. The damaging reputation of such brands leaves them to deal with the fallouts of counterfeits. Hence, such companies address them mainly through legal action, price and quality strategy. However, consumer characteristics and the random distribution of counterfeit products to the consumer types affect the effectiveness of a counter strategy. This paper aims to generate insights on how to leverage digital technology to curb counterfeit entities with consideration of consumer characteristics and the random distribution of counterfeits to them.Design/methodology/approachThe authors used game theory and vertical differentiation model to understand and encounter deceptive counterfeiting of brand products. The study understands the economic relationship between a brand product manufacturer and consumer types based on their awareness. Further, the authors have considered different cases in the model to gain useful insights.FindingsThe results reveal that when the consumers are proactive, informed and value-conscious brand product manufacturers take digital technology counterstrategy to earn the maximum revenue. Hence, this analysis highlights that the effectiveness of a counterstrategy critically depends on the consumer characteristics, whether they are proactive, informed or unaware.Practical implicationsThe study outlines that brand product manufacturers must emphasize on the digital supply chain, product redesign and product tracking facility to empower informed and value-conscious and proactive consumers. Moreover, the government should take steps to create awareness among uninformed consumers via information campaigns.Originality/valueThis paper incorporates the role of consumers and brand product manufacturers to understand and address the deceptive counterfeiting issue.

Legalizing Harmful Drugs: Government Participation and Optimal policies.

We are currently witnessing a shift in the approach to combat traffic and consumption of illegal harmful drugs, being cannabis legalization a prominent example. In this paper, we study how to optimally regulate the market for cannabis, in a setting where consumers differ in their utility from consumption of the psychoactive component of cannabis, THC, and suffer from misperception of the health damage it causes. We analyze this problem through a vertical differentiation model, where a black market firm and a public firm compete in prices and qualities (THC content). A paternalistic government would like to correct for the misperceived health damage caused by cannabis consumption, as well as to reduce the size of the black market. It is the undesirability of black market profits what explains that the first-best allocation cannot be decentralized. We find two possible equilibria, depending on whether the public firm serves those consumers with the highest or lowest willingness to pay for quality. Paradoxically, when the public firm serves those consumers with higher taste for THC, a lower average health damage is achieved together with a better economic result for the public firm.

Optimal taxation with positional considerations

AbstractThis paper analyzes the optimal commodity tax policy, in a generalized vertical differentiation model in which consumers have positional considerations. Consumers enjoy having a product which is better than that owned by others, and feel envy when others own a better product than them. We examine the impact of these positional considerations on the optimal tax and welfare when a monopoly produces two variants of such good. The standard result that the government should subsidize the product, can be reversed in our setting. In the presence of positional concerns, the optimal tax rate can be positive. Furthermore, the positional effects determine the level of the tax pass‐through on prices. Finally, the tax levied on the high‐quality variant affects the price of the low‐quality variant and vice versa.

Input price discrimination, pricing contract and social welfare

In this paper, we introduce input price discrimination into vertical product differentiation model to analyze the impact of input price discrimination on social welfare. We find that the input price discrimination improves the supply of high-quality products in the market, and lead to the increase of consumer surplus. The effect of input price discrimination on social welfare is influenced by the pricing contract of input. When the price of input is determined by upstream firm, the input price discrimination reduces social welfare. While the input price discrimination increases social welfare when the price of input is determined by bargaining of upstream and downstream firms.

How Consumers Choose the Green Electricity Product Instead of Conventional Electricity? A Welfare Analysis Approach

The aim of this article is to analyze theoretically whether changes in an access charge pricing policy can promote green electricity use. The model considers two hypothetical firms: One firm offers green electricity product, and the other firm provides conventional electricity. Each firm pays an access charge to the natural monopoly in order to have access to the transportation network. Through using a vertical differentiation model, we try to analyze the link between the access charges paid by the two firms and the qualities offered. We also attempt to explain why the consumers do not often choose green electricity. Finally, we suggest a new policy that can lead the consumers to choose the green electricity product instead of conventional electricity. Our model shows that changes in the access charge pricing policies can constitute a relevant component in the reforms of the electricity sector and can have impacts on the consumption of the green electricity. A differentiating access charge policy could allow a better penetration of the green electricity product and an increase in the social welfare when consumers have greater preferences in environmental qualities. Otherwise, their preservation at a uniform level is desirable in order to maintain the competition. JEL Classifications: B21, C72, L13, Q21, P28

Is it rational for a large-retailer to sell an own-brand product similar to the branded product of a large manufacturer? A Vertical Product Differentiation Model

A theoretical model was constructed to investigate the conditions that a large retailer must satisfy to increase the quality of the retailer-owned brands towards a greater number of groceries. The key result shows that the restraint given by a vertical integration scheme (producer-distributor) is relaxed for a higher quality-production cost ratio under the assumption of modelling with endogenous quality. Another finding is that the national brand´s production is not altered, which is explained by the fact that this brand is demanded by consumers with high willingness to pay for it. However, the wholesale price decreases and hence the manufacturer’s profit always falls as the quality of own brands rises. This is consistent with the argument that the retailer improves its negotiation capacity with the private manufacturer when it sells an own brand that is a close substitute for the manufacturer’s label, which always forces the wholesale price of the branded product down.

Quality Competition and Market-Share Leadership in Network Industries

Abstract This paper incorporates network externalities into a model of vertical product differentiation to examine how firms determine product quality and network size. We show that, with significant network benefits from quality improvement, the effects of network externalities differ depending on the type of competition. In response to an increase in network externalities, vertical product differentiation enlarges under price competition but shrinks under quantity competition. Moreover, under price competition, the network size of a high-quality product increases, whereas that of a low-quality product decreases for a sufficiently large extent of network externalities, resulting in a reversal in the leading position in terms of network size from the low- to the high-quality product. By contrast, the network sizes of high- and low-quality products both increase under quantity competition; moreover, the gap between their network sizes shrinks for a sufficiently large extent of network externalities.

Revenge consumption, government‐led voucher, and social welfare

This paper considers revenge consumption and government vouchers directly provided to the consumers in a duopoly model of vertical product differentiation. We find that revenge consumption will raise consumer surplus and social welfare. The government issuing vouchers will further push up consumer surplus and social welfare; however, facing the wave of revenge consumption, the government purposely want to recover the slowdown economy caused by the pandemic spread-out, should fully consider the quality difference of products and issue different discount rate voucher. For the producer, whether the government issuing vouchers increase firm's profit depends on the degree of revenge consumption and product differentiation.

FDI and quality-enhancing technology spillovers

When Northern firms undertake FDI in the South, their superior technology spills over to Southern firms and enables Southern firms to enhance their product quality. This paper explores quality-enhancing technology spillovers in an international duopoly model of vertical product differentiation. We find that the Northern firm strategically reduces its product quality to limit the amount of technology spillovers upon FDI. The trade-off between the Northern firm’s endogenous product quality choice and technology spillovers—similar to that between R&D and technology spillovers as discussed previously–plays a critical role in welfare consequences and policy implications of quality-enhancing technology spillovers.

수직적 차별화 시장에서 진입기업의 서비스 다양화와 품질전략

Firms often design product or service lines by segmenting their market on quality attribute. This paper examines the firms’ optimal quality choices in a duopoly model of vertical differentiation. In a two-stage game model studied here, there are two firms, entrant and incumbent, competing on price with three different quality services. The entrant offers two different quality services, one is superior to the incumbent monopolist’s service quality and the other is inferior one. They face consumers who prefer a higher quality service to a lower one, but differ in how much they are willing to pay for quality. The paper shows that the entrant engages in maximal services differentiation, i.e. selects both the highest and lowest technologically feasible quality services in order not to trigger a low price from the rival, and thus price competition is softened. Moreover, the incumbent tries to set the intermediate quality to the average of the entrant’s two extreme service qualities.

Ecolabel: Is More Information Better?

We study in this paper the effect of the type of information provided by an ecolabel. For this purpose, in the framework of a model of vertical differentiation, we compare the effects of a partial information label (Type I) and a complete information label (Type III) on firms’ profits, industry profit, consumers’ surplus, environmental damage and social welfare. A partial information label indicates that the environmental quality of a good exceeds some given threshold. The authority issuing a partial information label chooses its labeling criteria while maximizing the social welfare. A complete information label indicates the exact environmental quality chosen by firms. We prove that while a partial information label always improves the social welfare and deteriorates the green firm profit compared to a complete information label, the comparison between the two types of ecolabel in terms of the brown firm’s profit, the industry’s profit, the consumers surplus and the environment depends in a non-obvious way on the marginal cost of quality and on the environmental sensitivity to quality.

Revenge consumption, product quality, and welfare

Revenge consumption, the situation in which the demand for specific goods and services suddenly skyrockets and remains high for an extended period of time, is a relatively new economic phenomenon observed recently in many cities around the world after the easing of restrictions associated with the coronavirus pandemic in 2020 and 2021. We study welfare implications of revenge consumption in a model of vertical product differentiation. We show that revenge consumption induces producing firms to enhance the quality levels and raise prices on their products. As the level of revenge consumption increases, social welfare initially increases but it eventually declines. Results, which hold across monopoly, duopolistic competition, and national brand-private label competition models, provide useful information for public policy.

Greenness as a Differentiating Strategy

In a vertical differentiation model, we study a market where consumers, depending on their level of environmental consciousness, value the greenness of the product they consume and are distributed according to a Kumaraswamy distribution. Three scenarios are studied: only one firm takes some green measures and firms compete upon prices; only one firm takes some green measures, and this firm acts as the leader of the price competition; and finally, both firms choose their level of greenness and compete upon their location and price. The results suggest that as consumers become more environmentally conscious, the marginal consumer and the greener firm’s location move to the right. In contrast, the less green firm’s response is non-monotonic. In fact, when the two firms choose their location along with their prices, the latter firm chooses to produce a less green product in response to more environmentally conscious consumers. In the extreme case where all consumers are fully environmentally conscious, the latter firm produces a brown product and sells it at a price equal to its marginal cost. In this case, the greener firm’s price and location choices make the consumers indifferent between the two products. These results could explain why despite all the improvements in the consumers’ environmental consciousness, brown (in its general term) products are still widely produced and consumed, even by environmentally conscious consumers.

Strategic outsourcing and quality choice: Is a vertical integration model sustainable?

This paper uses two versions of a vertical product differentiation model with price competition to investigate how strategic behavior between rival firms influences which organizational production mode each firm adopts: that is, either vertical integration or outsourcing. We show that not only a symmetric configuration, where both high‐ and low‐quality firms outsource, but also an asymmetric configuration, where the high‐quality firm produces in‐house whereas the low‐quality firm outsources, are acceptable as a subgame‐perfect equilibrium outcome. We explore the implications of these results in light of the recent slump in business of Japanese electronics enterprises in the flat‐panel television industry.