Better product at same cost, lower sales and lower welfare

We consider a high-quality dominant firm facing a low-quality competitive fringe. We show that the dominant firm's quantity is (weakly) increasing in its quality if and only if its marginal cost (weakly) exceeds that of the fringe; otherwise it is strictly decreasing in quality. This result is driven by the fact that a quality increase causes the marginal revenue curve to rotate clockwise, rather than shift outwards, and at a height equal to the fringe firms' marginal cost. This fact, combined with the dominant firm's MR=MC condition, determines the result. For closely related reasons, the effect of a quality increase on consumer welfare also depends on the relationship between the costs. It is possible that all consumers are (weakly) better off, that some are better off and some worse off, or that all are (weakly) worse off. We also consider several extensions and variations of the model.