Quality Improvement to Meet Competitive Fringe

Abstract

We investigate what kind of competitive pressure induces existing firms to engage in more intensive innovation activities. We examine two types of competitive pressure: a price decrease in competitive fringe firms and a quality improvement therein. We use an oligopoly model with vertical differentiation to investigate this question. We show that a decrease in the exogenous price of competitive firms induces the two existent leading firms (one high-quality firm and one mid-quality firm) to engage in quality investments more if the ex ante quality level of the high quality product is large enough; otherwise, only the mid-quality firm engages more in quality investment. We also show that an increase in the exogenous quality level of competitive firms diminishes the incentive of the mid-quality firm to engage in quality investments.

Keywords: fringe firms, competitive pressure, investments, vertical differentiation

JEL Classification: L13, O31, D43