Quality as vertical Product Differentiation Proposition 12.2 The firm producing the higher-quality brand charges a higher price even if the production cost for low-quality products is the same as the production cost of high-quality products Substituting(12.7)into(12. 5) yields that 丌A(a,b) 1[2(6-a)2_(b-a)21_b-a 9 9 9 (12.8) 4(b 丌B(a,b) 1(b 9 We now move to the first period, where firm A takes be as given and maximizes t, (a, be) given in (2.8), whereas firm B takes a as given and maximizes ae, b) It is easy to see that firm A would choose to produce the lowest possible quality and locate at ae=0, whereas firm B would choose to produce the highest possible quality and locate at be This result is known as the principle of maximum differentiation. Formally
Quality as Vertical Product Differentiation
Market Structure, Quality, and Durability There is an extensive literature debating the relationship between the degree of a firm's monopoly power and the quality or durability it chooses to build into a product(see a survey article by schmalensee 1979]) Kleiman and ophir(1966)and Levhari and Srinivasan(1969), concluded that firms with monopoly power have the incentives to produce goods of lower durability than would be produced by firms in a competitive market
Market Structure, Quality, and Durability • There is an extensive literature debating the relationship between the degree of a firm's monopoly power and the quality or durability it chooses to build into a product (see a survey article by Schmalensee [1979]). • Kleiman and Ophir (1966) and Levhari and Srinivasan (1969), concluded that firms with monopoly power have the incentives to produce goods of lower durability than would be produced by firms in a competitive market
Market Structure, Quality, and Durability Swan(1970a, b, 1971)has demonstrated that there is actually no implied relationship between monopoly power and durability-Swan's independence result Levhari and peles(1973)demonstrated that durability built in a product produced by a monopoly can be longer or shorter than under competition. In addition they have shown that partial regulation of a monopoly that chooses strategies of quantity produced (or price) and durability (or quality)can reduce welfare, where partial regulation is defined as a restriction by the regulating authority on either the quantity produced or the quality but not on both
Market Structure, Quality, and Durability • Swan (1970a, b, 1971) has demonstrated that there is actually no implied relationship between monopoly power and durability—Swan's independence result. • Levhari and Peles (1973) demonstrated that durability built in a product produced by a monopoly can be longer or shorter than under competition. In addition, they have shown that partial regulation of a monopoly that chooses strategies of quantity produced (or price) and durability (or quality) can reduce welfare, where partial regulation is defined as a restriction by the regulating authority on either the quantity produced or the quality but not on both
Market Structure, Quality, and Durability Kihlstrom and levhari(1977)examine the robustness of Swan's result by analyzing the effect of increasing returns-to-scale (irs) technologies on the production of durability Spence(1975)developed a fixed-cost (implying an IRS technology)model to measure the divergence between the socially optimal quality level and the monopoly's equilibrium quality level
Market Structure, Quality, and Durability • Kihlstrom and Levhari (1977) examine the robustness of Swan's result by analyzing the effect of increasing returns-to-scale (IRS) technologies on the production of durability. • Spence (1975) developed a fixed-cost (implying an IRS technology) model to measure the divergence between the socially optimal quality level and the monopoly's equilibrium quality level
Market Structure, Quality, and Durability Consider a monopoly firm selling light bulbs with variable durability a short-durability light bulb yielding light services for one period only, at unit cost c > a long-durability light bulb yielding light services for two periods, at unit cost c 0<cs<V0<cL<2V. and cs< a consumer lives and desires light services for two periods. Assume that the consumer is willing to pay an amount of $v(v>0) per each period of light services
Market Structure, Quality, and Durability • Consider a monopoly firm selling light bulbs with variable durability: a short-durability light bulb yielding light services for one period only, at unit cost 𝑐 𝑆 . a long-durability light bulb yielding light services for two periods, at unit cost 𝑐 𝐿 . • A consumer lives and desires light services for two periods. Assume that the consumer is willing to pay an amount of $V (V > 0) per each period of light services