DP10027 Dynamic Entry in Vertically Differentiated Markets

Author(s): Raphael Auer, Philip Sauré
Publication Date: June 2014
Date Revised: October 2016
Keyword(s): Endogenous Growth, Natural Monopoly, Non-homogenous Preferences, Product Quality, Quality Ladders, Vertical Differentiation
JEL(s): D4, D43, L11, L13, L15, O4
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10027

We develop a model of vertical innovation in which firms incur a market entry cost and choose a unique level of quality. Once established, firms compete for market shares, selling to consumers with heterogeneous tastes for quality. The equilibrium of the pricing game exists and is unique within our setup. Exogenous productivity growth induces firms to enter the market sequentially at the top end of the quality spectrum. A central feature of the model is that optimization problems of consecutive entrants are self-similar so that new firms enter in constant time-intervals and choose qualities that are a constant fraction higher than incumbent qualities. The asymmetries of quality choice, which inevitably arise because the quality spectrum has top and a bottom, is thus overcome by sequential entry. Our main contribution lies in handling these asymmetries.