On the Effects of Raised Rival's Costs

This paper examines the effects of a rival's cost increase in a vertically differentiated market with endogenous product qualities. It provides cost-side and demand-side conditions under which a firm gains and under which it loses from its rival's cost increase. We show how the gain or loss depends on: (i) the absence or presence of outside options for consumers; (ii) the degree of heterogeneity in consumer taste for quality; (iii) whether the cost of producing quality involves fixed costs or variable costs; and (iv) the relative quality-production efficiencies of the competing firms.

Automated summary

This study examines the effects of a rival's cost increase on product quality in a vertically differentiated market, providing conditions to explain whether a company gains or loses when its competitor's costs increase, and how this gain or loss depends on consumer choices, consumer taste for quality, quality production costs, and competing firms' production efficiencies.