Long-Run Market Configurations in a Dynamic Quality-Ladder Model with Heterogeneity

Abstract

We study the long-run market configurations in a quality-ladder dynamic model. Specifically, we assume that the return to investment in quality differs across the firms. That is, for a given level of investment, one firm has a higher probability to raise the quality of the good it produces. We show that the model can generate five different types of long-run market configurations (market collapse, market collapse or monopoly, monopoly, duopoly and monopoly, and duopoly). A high degree of heterogeneity in the return to investment can mitigate the effect of highly reversible investments on the probability of market collapse, giving rise to non-negligible probabilities of observing a duopoly or even dominance of the firm with the lowest return to investment.