Minimum Quality Standards and Equilibrium Selection with.pdf

Minimum Quality Standards and Equilibrium Selection with Asymmetric Firms. ∗ †‡ Olivier BONROY , Christos CONSTANTATOS June 2005 Abstract In a vertically differentiated market with cost asymmetries, the risk domi- nance criterion selects the equilibrium where the high quality is produced by the efficient firm. We show that a sufficiently high Minimum Quality Standard reverses equilibrium selection. Hence, MQS may be used in order to increase a domestic firm’s profit at the expense of a more efficient foreign rival. This pro- duces higher domestic and lower world welfare. Since the protectionist impact of MQS comes through equilibrium targeting rather than directly affecting equilibrium outcomes, it cannot be easily detected. JEL classifi cation: L13, L5, F13; Keywords : Vertical product differentia- tion, Minimum quality standards, Equilibrium selection, Protectionism. ∗ ´ Corresponding authors: Centre for Research in the Economics of Agrifood (CREA), Laval University, Pavillon Paul-Comtois, Qu´ebec G1K 7P4 Canada, E mail: olivier.bonroy@eac.ulaval.ca. †University of Macedonia, and GREEN, Universit´e Laval. ‡This paper was partly written while Bonroy was visiting the GREEN, Universit´e Laval. We are grateful to Philippe Barla, N. M. Hung, Jean-Philippe Gervais, Bruno Larue and the participants to the 31st EARIE annual conference for comments and encouragement. Responsibility of any remaining errors and ommissions is ours. Bonroy acknowledges financial support from the French Ministry of Foreign Affairs.