Vertical Product Differentiation, Market Entry, and Welfare

This paper analyses a model of vertical product differentiation
with one incumbent and one entrant firm. It is shown that if firms
can produce only one quality level welfare in this entry game can
be lower than in monopoly. This is the case if qualities are
strategic complements because the incumbent may distort its quality
downwards. If firms can produce a quality range and practice
non-linear pricing welfare in case of entry deterrence is higher
than in monopoly because the incumbent enlarges its product line.
If entry is accommodated consumer rent increases but the
consequences on welfare are ambiguous.