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RESEARCH PRODUCT

Spatial Competition in Quality

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We develop a model of vertical innovation in which firms incur a market entry cost and position themselves in the quality space. Once established, firms compete monopolistically, selling to consumers with heterogeneous tastes for quality. We establish the general existence and conditional uniqueness of the pricing game in such vertically differentiated markets with a potentially large number of active firms. Turning to firms’ entry decisions, exogenously growing productivities induce firms to enter the market sequentially at the top end of the quality spectrum. We spell out the conditions under which the entry problem is replicated over time so that each new entrant improves incumbent qualities in fixed proportions. Sequential market entry overcomes the asymmetry of the location problem that unavoidably arises in the quality space: the quality spectrum has a top and a bottom end. Our main technical contribution lies in handling this asymmetry, a feature absent in Salop (1979) and other circular representations of Hotelling (1929) and Lancaster (1966).