Vertical Product Differentiation, Quality Standards, and International Trade Policy
This paper studies the influence of minimum quality standards in a partial-equilibrium model of vertical product differentiation and trade in which duopolistic firms face quality-dependent costs and compete on quality and price in two segmented markets. Three alternative standard setting arrangements are Full Harmonization, National Treatment and Mutual Recognition. Under these alternatives, standards can be found that increase welfare in both regions. The analysis integrates the governments’ choice of a particular standard setting alternative into the model. Mutual Recognition emerges as one regulatory alternative that always improves welfare in both regions when compared to the case without regulation. Under certain cost conditions, both regions will prefer Mutual Recognition over the alternatives.
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