How does income inequality affect market outcomes in vertically differentiated markets?

Anna V. Yurko*

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

8 Citations (Scopus)

Abstract

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. (C) 2010 Elsevier B.V. All rights reserved.

Original languageEnglish
Pages (from-to)493-503
Number of pages11
JournalInternational Journal of Industrial Organization
Volume29
Issue number4
DOIs
Publication statusPublished - Jul-2011

Keywords

  • Vertical differentiation
  • Income inequality
  • Computational economics
  • PRODUCT DIFFERENTIATION
  • ENDOGENOUS QUALITY
  • PRICE-COMPETITION
  • CHOICE
  • INDUSTRY

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