Quality Choices and Endogenous Market Structure When ‘Location’ Matters

Previous literature has analyzed the quality-price decisions and the market structure that arises endogenously, in a setup where variable production costs depend on quality. This paper goes one step further by admitting the existence of "transportation" costs for consumers who buy from the firm located at the "periphery", where "periphery" can have a spatial interpretation (like in the housing market) or an interpretation related with some pre-existent feature of the firms, that leads consumers to value differently products with the same hedonic quality. Our results show an "asymmetry" arising from different locations. The firm with locational advantage may be able to behave as a partial coverage monopolist. Moreover, when a duopoly emerges in equilibrium, if the high-quality firm is located in the periphery, qualities offered will be higher than in the absence of locational asymmetries. The reason is that the high-quality firm will try to compensate its locational disadvantage by further increasing quality, which leads the low-quality firm to do the same. This puts in evidence a sort of "substitutability" effect between location and quality in firms' strategic interaction