Spatial Competition in a Differentiated Market with Asymmetric Costs

Spatial quality choice is introduced, where consumers are horizontally differentiated by taste and firms vertically differentiated by quality location, within an equilibrium model of duopoly competition characterized by asymmetric fixed and variable costs. Firms choose quality location followed by prices but then may vertically re-locate their quality offerings based on changing horizontal consumer taste. A monopolistic equilibrium solution arises with firms achieving positive economic profits through price-quality markups exceeding marginal costs. Under strict inequality conditions, each firm acts as a monopolistic competitor within a range of quality choices governed by multiple relative differentiation outcomes. On the other hand, vertical re-location exhibits a resistance to change on the part of vertically located firms such that firms dislike quality re-location and prefer stable preferences in quality. Such resistance to change is overcome by firms re-locating their quality offerings to maximize monopolistic brand-space gains. It is argued that more horizontal differentiation may force more product differentiation by vertical quality relocation. A relative change in quality preferences may result in wider quality spreads in the market through vertical quality re-locations, even though the resistance to change arguments may still hold good.