Introduction

The feature of product differentiation on which we have focused up till now has been variety. In some cases (as with Hotelling), we have had in mind a taste parameter which we have thought of as being distributed across consumers. In others, such as our discussion of Chamberlin, we assumed a primitive desire for variety. In each case we have looked at the optimal variety to service the needs of consumers and what it is that limits the market's ability to achieve this. In this chapter we start our examination of another dimension of product differentiation that matters for people's utility: the question of product quality and the relationship between quality choice and market structure. In this chapter we shall restrict the discussion to the choice of a single quality level or, to be more precise, when we consider market structures other than monopoly, we shall only consider symmetric equilibria in which firms choose the same quality level. The discussion of product differentiation by quality is the theme of the next chapter on vertical differentiation. In that, the market equilibrium may be characterised by the co-existence of several levels of quality.

In the current discussion we follow the approach originally taken by Dorfman and Steiner (1954) in supposing that it can be represented by some scalar measure, z, such that the higher is z the higher are unit costs and the more highly do consumers value any particular quantity of the good.