Quality Improvement to Meet Competitive Fringe

We investigate what kind of competitive pressure induces existing firms to engage in more intensive innovation activities. We examine two types of competitive pressure: a price decrease in competitive fringe firms and a quality improvement therein. We use an oligopoly model with vertical differentiation to investigate this question. We show that a decrease in the exogenous price of competitive firms induces the two existent leading firms (one high-quality firm and one mid-quality firm) to engage in quality investments more if the ex ante quality level of the high quality product is large enough; otherwise, only the mid-quality firm engages more in quality investment. We also show that an increase in the exogenous quality level of competitive firms diminishes the incentive of the mid-quality firm to engage in quality investments.