Protection by Regulatory Standards: An Example with Forced Exit

The recent extensive study of vertical product differentiation models has allowed for the analysis of international trade issues in the presence of country asymmetries in terms of product qualities, technology, costs, market size, and income. In the presence of such asymmetries, national industries will either be market leaders or be lagging behind in the international market place in terms of their product qualities. The resulting asymmetry in profits creates powerful incentives for lagging industries as well as their national governments to reverse this situation to their advantage, i.e. to promote leadership in terms of product qualities. This note presents an example where a minimum quality standard facilitates increased product quality by the domestic firm as well as exit of the foreign firm.