DP1793 Strategic Quality Choice with Minimum Quality Standards

Author(s): Stefan Lutz, Thomas P Lyon, John W Maxwell
Publication Date: January 1998
Keyword(s): Environment, Product Differentiation, Quality, Regulation
JEL(s): L13, L15, L51, Q28
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1793

In many markets governments set minimum quality standards while some sellers choose to compete on the basis of quality by exceeding them. Such ?high-quality? strategies often win public acclaim, especially when ?environmental friendliness? is the dimension along which firms are differentiated. We analyse this phenomenon using a duopoly model of vertical product differentiation. A minimum quality standard leads both the high-quality and the low-quality firm to increase product qualities, lower prices, and increase quantities sold. As a result, total welfare increases. Industry profits fall, however, because reduced quality differentiation intensifies price competition. If the high-quality firm can commit to a quality level before regulations are promulgated, it induces the regulator to weaken its standards, and welfare falls.