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How Does Income Inequality Affect Market Outcomes in Vertically Differentiated Markets?

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  • Yurko, Anna

Abstract

The distribution of consumer incomes is a key factor in determining the structure of a vertically differentiated industry when consumer's willingness to pay depends on his income. This paper computes the Shaked and Sutton (1982) model for a general specification of consumers' income distribution to investigate the effect of inequality on firms' entry, product quality, and pricing decisions. The main findings are that greater inequality in consumer incomes leads to the entry of more firms and results in more intense quality competition among the entrants. This is due to the elasticity of consumer demand for quality being higher in more inegalitarian economies. More intense quality competition among firms causes them to locate their products in higher ranges of the quality spectrum, closer to each other, decreasing the degree of product differentiation. Competition between more similar products tends to reduce their prices. However, when income inequality is very high, the top quality producer chooses to serve only the rich segment of the market, and the low price elasticity of demand of these consumers allows him to charge a higher price. The conclusion is that income inequality has important implications for the degree of product differentiation, price level, industry concentration, and consumer welfare.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4028.

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Date of creation: May 2006
Date of revision: Jul 2007
Handle: RePEc:pra:mprapa:4028

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Keywords: vertical differentiation; income inequality; computational game theory;

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References

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  1. De Fraja, Giovanni, 1996. "Product line competition in vertically differentiated markets," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 14(3), pages 389-414, May.
  2. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, Elsevier, vol. 20(3), pages 340-359, June.
  3. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  4. Corrado Benassi & Alessandra Chirco & Caterina Colombo, 2006. "Vertical Differentiation And The Distribution Of Income," Bulletin of Economic Research, Wiley Blackwell, Wiley Blackwell, vol. 58(4), pages 345-367, October.
  5. Maxim Pinkovskiy & Xavier Sala-i-Martin, 2009. "Parametric Estimations of the World Distribution of Income," NBER Working Papers 15433, National Bureau of Economic Research, Inc.
  6. Tullio Jappelli & Luigi Pistaferri, 2010. "Does Consumption Inequality Track Income Inequality in Italy?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 133-153, January.
  7. Ulrich Lehmann-Grube, 1997. "Strategic Choice of Quality When Quality is Costly: The Persistence of the High-Quality Advantage," RAND Journal of Economics, The RAND Corporation, vol. 28(2), pages 372-384, Summer.
  8. Dorfman, Robert, 1979. "A Formula for the Gini Coefficient," The Review of Economics and Statistics, MIT Press, vol. 61(1), pages 146-49, February.
  9. Justin P. Johnson & David P. Myatt, 2003. "Multiproduct Quality Competition: Fighting Brands and Product Line Pruning," American Economic Review, American Economic Association, American Economic Association, vol. 93(3), pages 748-774, June.
  10. Anthony C. Atkinson, 2003. "Income Inequality in OECD Countries: Data and Explanations," CESifo Working Paper Series 881, CESifo Group Munich.
  11. Steven Berry & Joel Waldfogel, 2003. "Product Quality and Market Size," NBER Working Papers 9675, National Bureau of Economic Research, Inc.
  12. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, Elsevier, vol. 18(2), pages 301-317, August.
  13. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
  14. Shaked, Avner & Sutton, John, 1987. "Product Differentiation and Industrial Structure," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 36(2), pages 131-46, December.
  15. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, Econometric Society, vol. 51(5), pages 1469-83, September.
  16. Aoki, Reiko & Prusa, Thomas J., 1997. "Sequential versus simultaneous choice with endogenous quality," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 15(1), pages 103-121, February.
  17. Koen Caminada & Kees Goudswaard, 2001. "International Trends in Income Inequality and Social Policy," International Tax and Public Finance, Springer, Springer, vol. 8(4), pages 395-415, August.
  18. Jaskold Gabszewicz, J. & Thisse, J. -F., 1980. "Entry (and exit) in a differentiated industry," Journal of Economic Theory, Elsevier, Elsevier, vol. 22(2), pages 327-338, April.
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Cited by:
  1. OSHARIN, Alexander & THISSE, Jacques-François & USHCHEV, Philip & VERBUS, Valery, 2013. "Monopolistic competition and income dispersion," CORE Discussion Papers, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) 2013071, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Namrata Gulati & Prabal Roy Chowdhury, 2010. "Income inequality, neighbourhood effects and product quality," Indian Statistical Institute, Planning Unit, New Delhi Discussion Papers, Indian Statistical Institute, New Delhi, India 10-06, Indian Statistical Institute, New Delhi, India.

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