Regional science and urban economics vol:31 issue:5 pages:547-569
Often a quality improvement necessitates modifications of varietal product features. This paper studies firms' incentives to provide quality when this decision affects the goods' degree of perceived horizontal differentiation. We find that the quality level hinges crucially on the interaction between the quality and the varietal product attribute, We examine the outcome of a game where firms decide on quality and price relative to what a social planner would desire, If the interaction between quality and perceived horizontal differentiation is sufficiently positive, we find for the sequential game 'quality then price' that the private incentives to provide quality are excessive relative to the social optimum. As a result the level and the direction of interaction between the attributes determines whether there is excessive or insufficient provision of quality. (C) 2001 Elsevier Science B.V. All rights reserved.