We study a model of imperfect competition and limited production capacity, in which a choice of low product quality enables firms to increase total production. We find that in the presence of limited capacity, such reduced quality often results in increased social welfare. We also explore the relation between the extent of competition and the choice of quality. We find that, in some cases, reduced competition leads to increased production, decreased average quality, increases total welfare, and makes consumers better off. We next show that where the duopolists have different capacities, the small firm would always be willing to pay more than the large firm for an additional unit of capacity offered by an outside party. In contrast, a sale of a small capacity increment from the small to the large firm would sometimes increase total firms' profits. Last, we consider the possibility of a regulator-mandated quality standards. We demonstrate that such an intervention could either increase or decrease welfare, in either a monopoly or a duopoly market.
Melumad, Nahum, and Amir Ziv. "Reduced Quality and an Unlevel Playing Field Make Consumers Happier." Management Science 50 (December 2004): 1646-59.
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