DP1455 Vertical Product Differentiation and Entry Deterrence

Author(s): Stefan Lutz
Publication Date: August 1996
Keyword(s): Entry, Oligopoly, Product Differentiation, Quality Standards
JEL(s): L12, L13, L15
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1455

This paper studies how the existence of a potential entrant influences an incumbent?s choice of quality in a model of vertical product differentiation and entry. Both firms face fixed set-up costs and quality-dependent costs of production, and compete on quality and price. With identical quality-dependent costs, the incumbent will always deter entry if possible, i.e. if fixed costs are high. Quality will be set at a level lower than the optimal quality set if entry was accommodated. If entry is not blockaded, quality will be set at a level strictly lower than the optimal quality set under monopoly.