Minimum Quality Standards and Market Structure: When Regulation Eliminates the High-Quality Product

We study how minimum quality standards (MQSs) interact with market size when quality entails marginal production costs and non-recurring investment. In a vertically differentiated duopoly with endogenous quality choice, price competition, and an outside option, the unregulated duopoly remains viable at every positive market size because firms lower quality in smaller markets. A binding MQS restricts this adjustment and creates a strictly positive market-size viability boundary. Which firm reaches it first depends on market size relative to standard stringency. In relatively small markets, the constrained low-quality firm loses viability first. In relatively large markets, the unconstrained high-quality firm does so because induced upgrading raises its non-recurring investment burden. Crossing this boundary eliminates the high-quality product and yields a stable low-quality-only outcome, with no profitable re-entry by the high-quality firm. A marginally binding MQS raises welfare at every finite market size. When market size is sufficiently large relative to the investment burden, the welfare-maximizing standard is interior; when it is sufficiently small, duopoly viability binds first. The welfare-maximizing standard rises with market size. Separate policies that shrink the effective customer base or raise the non-recurring investment burden required for compliance can make an otherwise viable duopoly non-viable. The viability structure can also give a firm an incentive to support regulatory tightening that makes its rival non-viable.