How does income inequality affect market outcomes in vertically differentiated markets?
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 her income. This paper computes the Shaked and Sutton (1982) model for a lognormal distribution of consumer incomes 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. More intense quality competition raises the average quality of products in the market as firms compete for the shrinking share of higher-income consumers. With zero costs of quality improvements and an upper bound on the top quality or when costs of quality are fixed and rise sufficiently fast, greater heterogeneity of consumer incomes also reduces firms' incentives to differentiate their products. 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 charges 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.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Caminada, Koen & Goudswaard, Kees, 2001.
"International trends in income inequality and social policy,"
20181, University Library of Munich, Germany.
- Koen Caminada & Kees Goudswaard, 2001. "International Trends in Income Inequality and Social Policy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 8(4), pages 395-415, August.
- Aoki, Reiko & Prusa, Thomas J., 1997. "Sequential versus simultaneous choice with endogenous quality," International Journal of Industrial Organization, Elsevier, vol. 15(1), pages 103-121, February.
- 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.
- GABSZEWICZ, Jean J. & THISSE, Jacques-François, .
"Entry (and exit) in a differentiated industry,"
CORE Discussion Papers RP
400, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Tullio Jappelli & Luigi Pistaferri, 2009.
"Does Consumption Inequality Track Income Inequality in Italy?,"
CSEF Working Papers
229, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
- 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.
- A. B. Atkinson, 2003.
"Income Inequality in OECD Countries: Data and Explanations,"
CESifo Economic Studies,
CESifo, vol. 49(4), pages 479-513.
- Anthony C. Atkinson, 2003. "Income Inequality in OECD Countries: Data and Explanations," CESifo Working Paper Series 881, CESifo Group Munich.
- De Fraja, Giovanni, 1996. "Product line competition in vertically differentiated markets," International Journal of Industrial Organization, Elsevier, vol. 14(3), pages 389-414, May.
- Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
- 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.
- Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
- Berry, Steven & Waldfogel, Joel, 2005.
"Product Quality and Market Size,"
1, Yale University, Department of Economics.
- Dorfman, Robert, 1979. "A Formula for the Gini Coefficient," The Review of Economics and Statistics, MIT Press, vol. 61(1), pages 146-49, February.
- Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
- 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.
- Justin P. Johnson & David P. Myatt, 2003.
"Multiproduct Quality Competition: Fighting Brands and Product Line Pruning,"
American Economic Review,
American Economic Association, vol. 93(3), pages 748-774, June.
- David P. Myatt & Justin P. Johnson, 2002. "Multiproduct Quality Competition: Fighting Brands and Product Line Pruning," Economics Series Working Papers 105, University of Oxford, Department of Economics.
- Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
- Shaked, Avner & Sutton, John, 1987. "Product Differentiation and Industrial Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 36(2), pages 131-46, December.
- Corrado Benassi & Alessandra Chirco & Caterina Colombo, 2006. "Vertical Differentiation And The Distribution Of Income," Bulletin of Economic Research, Wiley Blackwell, vol. 58(4), pages 345-367, October.
When requesting a correction, please mention this item's handle: RePEc:eee:indorg:v:29:y:2011:i:4:p:493-503. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Shamier, Wendy)
If references are entirely missing, you can add them using this form.