The purpose of this paper is to explore the impact that minimum quality standards have on product quality when entrepreneurial innovation is considered.
The author develops a game-theoretic model. It is a standard vertical product differentiation model, but incorporates a minimum quality standard and uncertain entrepreneurial innovation.
While the minimum quality standard increases the expected quality of the low-quality product, under reasonable circumstances the expected quality of the high-quality good decreases. Thus, average quality can decrease with regulation intended to increase product quality.
Past research on minimum quality standards does not consider its impact on entrepreneurial effort when their innovation investments lead to uncertain outcomes.
Minimum quality standard regulation can have counterproductive impacts if the impact on entrepreneurs is not considered. The regulation can disincentivize entrepreneurs leading to lower quality products.
Regulation can be welfare reducing.
This paper is the first to incorporate entrepreneurial innovation into a product quality model to explore the impact of minimum quality standard regulation.
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