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We allow quality variations in a duopoly of locationally differentiated products à-la-Hotelling (1929). We analyze the impact of quality variations on the choices of the varieties produced. We show that in a sequential game of variety choice and subsequent quality and price choice there exist only maximal variety differentiation equilibria in pure strategies. Maximal variety differentiation is also the perfect pure strategies equilibrium of a sequential game of variety choice followed by quality choice and later by price choice. In both games there is minimal quality differentiation at equilibrium.
Nicholas Economides (Wed,) studied this question.
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