Economic integration in vertically differentiated markets

Abstract

We analyze trade liberalization in a vertically differentiated market with free entry. We consider two asymmetric countries each having a uniform income distribution of different width and density. Income distributions have common origin, so the "wider" country is also "richer", having higher average income. In the short run integration increases prices in the smaller country while it lowers those in the larger country (pure price effect). In the long run, when the fixed cost is quality - specific, the lower quality always increases in the smaller country while in the larger country it may increase or decrease. The price of the lower quality falls in both countries, despite quality improvements. The price of the high quality, a) for high (low) levels of the fixed cost increases in the small (large) country while it decreases in the large (small) country, b) for intermediate levels of the fixed cost, falls in both countries.

JEL Classification : L13, F12