We consider the following stage game : a domestic government chooses an import quota, then a domestic and a foreign Þrm choose their quality level before engaging a price competition. We Þrst show that the indirect effect of the quota on the sales of the domestic producer are different depending on whether his product quality is high or low. The analysis developed in Krishna [89] has to be amended when vertical, instead of horizontal, product differentiation applies. Despite the nonexistence of pure strategy Nash equilibria, we characterise all equilibria of the pricing game and solve the quality choice game : for loose quotas, both Þrms choose top quality while only one differentiates for tighter quotas. The optimal quota for the domestic government reduces the price competition and enables both Þrms to upgrade to the highest possible quality level for the beneÞt of domestic consumers. On the contrary, the foreign Þrm would prefer a very loose quota that generates quality differentiation and larger proÞts for her
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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number
1998018.
Find related papers by JEL classification: D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
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