Examining Externality on Welfare and Market Access Arising from Consumer Heterogeneity

Abstract

This paper extends the literature on spatial price–quality competition by looking into the welfare impact of increased consumer heterogeneity. This is done by incorporating consumer heterogeneity into a model where firms compete simultaneously in price and quality within a circular market framework. Consumers are assumed to have either high or low willingness to pay for quality, thereby capturing both vertical and horizontal product differentiation in the model. The analysis establishes that as consumer heterogeneity increases, welfare for low-preference consumers follows an inverted-U pattern. Initially, greater heterogeneity enhances welfare by inducing firms to offer higher-quality products at higher prices. However, beyond a threshold, rising production costs and hence, price increases outweigh these benefits, leading to reduced welfare and access to the market for consumers with a low preference for quality. This finding highlights a crucial trade-off between quality improvement and affordability, and hence, in market access. This offers an important insight into framing policies that aim to promote inclusive market access and maintain balanced quality competition.

JEL Classifications: D21, D62, I31, D49