Quality Choice, Trade Policy, and Firm Incentives

Quality choice is examined in a duopoly with one foreign and one domestic firm where consumers have similar preferences for quality but different preferences for brands. Firms make quality commitments prior to choosing price and policy intervention assumes several forms. The policy conclusions depend on whether firms face "set-up" costs in raising product quality. In the absence of set-up costs, both domestic and foreign firms make socially optimal quality choices. In the presence of set-up costs, the foreign firm, and often the domestic firm, sets quality below the socially optimal level. Incomplete information alters these conclusions, however. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.