Abstract

The present paper is dealing with the link between quality and market power in the context of saturation goods. Investigating the conditions of a quality improvement to increase demand elasticity, the findings suggest the existence of a saturation level which depends on quality. Following Lancasters approach to consumer theory, an appropriate definition of quality is proposed. This specification allows a natural interpretation of the bias of the quality choice by a monopolist. Furthermore, we investigate firm behavior both in an imperfect competitive output market, and in oligopoly to find that firms can build up market power and increase profits by improving quality. Thus a firm's competitiveness can be traced back to its ability to produce quality more efficiently than its competitors.