Quality Choice, Trade Policy, and Firm Incentives

James D. Reitzes
Working Paper:

We examine quality choice in a duopoly model with one foreign and one domestic firm. where consumers show similar preferences for quality but different preferences for brands. Firms set quality prior to choosing price; and. the interaction between firms and policymakers assumes several forms. Our conclusions differ depending on whether firms face "set-up" costs in establishing higher quality levels. When these costs are absent, both domestic and foreign firms typically set quality at socially optimal levels. When these costs are present. the foreign firm [and often the domestic firm] sets quality below the socially optimal level. These results change when firms use their quality choices to signal cost information to policymakers or rivals.