Quality-related Cost,Income Distribution And Vertical Product Differentiation

The previous literatures on the quality-price competition of Duopoly vary greatly in the assumption for the cost of quality improvement, and most of which assume the consumer income (preference) to be evenly distributed. Under the profit maximization assumption the overwhelming majority of the literature conclude that the two firms will make the quality of their products maximum different from each other or to be a certain ratio, i.e. the principle of maximum differentiation or fixed ratio. And it is generally assumed that the firm of high-quality product will have higher profit that is so-called the high-quality advantage. This paper continues to explore whether the principle of high-quality advantage proves to be true and whether vertical product differentiation complies with the above-mentioned principles based on the beta distribution of income of consumes combined with of various forms of cost. And also this paper discusses the influence of the forms of cost and the various income distributions of consumers on the market structure and social welfare. In addition, on the basis of this study, this paper will further analyze some specific impact on social welfare, decision-making of firms, market structure, such as social programmers, minimum quality standards, the game sequence, network externalities, the trade and R&D policy etc.Our Study found that the two firms under the profit maximization assumption will choose different products in quality for production, and the principle of the minimum differentiation is not valid. The costs of quality improvement and different forms of income distribution both have a major impact on the decision-making of firms and market Equilibrium.In the absence of cost of quality improvement, regardless of how the income distribution of, the two firms will make their products to be the most different in quality and the high-quality firm will make higher profit, i.e. the principle of high quality advantage is valid. The heavier the right skewed income distribution of consumers or the bigger the ratio of high-income-consumer, the greater the Herfindahl index is and the higher the degree of market concentration is.With quality dependent fixed costs the two firms will not maximize product differentiation. The bigger the R&D cost coefficient is, the smaller the difference in quality of products. For The left skewed or uniform distribution, high-quality advantage will hold; when consumers have the right skewed distribution, the low quality firm will receive a higher return, i.e. "the low-quality advantage". Also the emergence of low-quality advantage does not require the relatively high market share for the low quality firm.If the costs of quality improvement are variable ones, then the two firms will maximize their product differentiation, the firm with relatively larger market share has a higher profit. Otherwise a lower profit. Under the assumption that the cost of quality improving is linear, if the cost coefficient is very high, then one of the two firms will withdraw from the market because of too small a market share. The too big or too small cost coefficient both raises the concentration of the industry.If the cost of quality improving assumed to be the fixed: (1)when the market is not fully covered, the consumers concentrating on the middle of the market or the ration of middle-income consumers is high, then in equilibrium only one firm can survive, accordingly the market structure will experience Significant changes;(2)if there to be minimum quality standard ,then the profits of the two firms will decrease ,consumers surplus will rise, as a result the whole social welfare will go down, the higher the minimum quality standard is ,the more obvious above-mentioned effect;(3)in dynamic game, the Incumbent firm is not necessarily choose the strategy of high quality for the maintenance of advantage of the first mover. The choice of quality-locating strategy of the leading firm hinges on the form of income distribution of the consumers. In Innovation-imitation game, if imitator has a cost disadvantage, the innovative usually chooses the low-quality strategy while the imitator high-quality one and the second-mover has a higher profit.With network effect being, the stronger it is, the bigger the high-quality firm. Though the profit of the two firms goes down, the ratio of the profit of the high-quality to the low-quality becomes bigger and the high quality advantage becomes more obvious. We show in this paper that network effect has the self-reinforcing mechanism—the bigger the market share is, the bigger the consumer surplus, vice versa;(5)in international trade, the income distribution of one country will bring about changes of policy of imports and exports. The policy of R&D will also give rise to the quality reversion, i.e. a country which at first produces the low quality product becomes one producing high quality product lastly. The more the subsidy of one country is, the more emergent the phenomenon of quality reversion become. Also, the higher income standard of one country is, the more effective its R&D policy.