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 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.
|Date of creation:||May 2006|
|Date of revision:||Jul 2007|
|Contact details of provider:|| Postal: |
Web page: https://mpra.ub.uni-muenchen.de
More information through EDIRC
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.:
- Jaskold Gabszewicz, J. & Thisse, J. -F., 1980.
"Entry (and exit) in a differentiated industry,"
Journal of Economic Theory,
Elsevier, vol. 22(2), pages 327-338, April.
- Shaked, Avner & Sutton, John, 1987. "Product Differentiation and Industrial Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 36(2), pages 131-46, December.
- Berry, Steven & Waldfogel, Joel, 2005.
"Product Quality and Market Size,"
1, Yale University, Department of Economics.
- Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
- Anthony C. Atkinson, 2003. "Income Inequality in OECD Countries: Data and Explanations," CESifo Working Paper Series 881, CESifo Group Munich.
- Koen Caminada & Kees Goudswaard, 2001.
"International Trends in Income Inequality and Social Policy,"
International Tax and Public Finance,
Springer, vol. 8(4), pages 395-415, August.
- Caminada, Koen & Goudswaard, Kees, 2001. "International trends in income inequality and social policy," MPRA Paper 20181, University Library of Munich, Germany.
- 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.
- 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.
- Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
- 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.
- 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.
- 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.
- Dorfman, Robert, 1979. "A Formula for the Gini Coefficient," The Review of Economics and Statistics, MIT Press, vol. 61(1), pages 146-49, February.
- 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.
- 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.
- De Fraja, Giovanni, 1996. "Product line competition in vertically differentiated markets," International Journal of Industrial Organization, Elsevier, vol. 14(3), pages 389-414, May.
- 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.
- Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:4028. 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: (Ekkehart Schlicht)
If references are entirely missing, you can add them using this form.