Low Quality Leadership in Vertically Differentiated Duopoly

According to the business literature a firm's competitive position is determined by the nature of the market. In a 'premium' market, profit leadership falls to firms of- fering high quality, whereas in a 'value' market, it falls to low quality providers, which on grounds of a cost advantage capture a major market share. We incorporate this idea into a model of a vertically differentiated duopoly. In contrast to more conventional models, we assume that gross surplus from unit consumption consists of a benefit from quality and a baseline benefit. Consumers are heterogeneous (homoge-neous) with regard to the former (latter). Marginal cost increases in quality. We derive the quality-then-price equilibrium in a non-covered market and show that a re-duction in (maximum) willingness to pay relative to baseline benefit induces low quality leadership first in market share and subsequently in profit. Under low quality profit leadership, a minimum quality standard reduces consumer surplus if con-sumer's willingness to pay is sufficiently low and always reduces profits and welfare.