Heterogeneous Firms, Quality and Trade

We present a model of quality choice in a world of heterogeneous \u85rms and non-constant markups. In equilibrium, some \u85rms exit the market, others produce output but choose no quality upgrades, and the most productive \u85rms produce both output and quality upgrades. For these \u85rms, the more productive they are, the more quality they choose. In line with recent empirical \u85ndings, the model shows that prices can increase in productivity, that developing countries have an incentive to export more quality goods to developed countries than developing, and that competition in endogenous sunk costs industries does not have to lead to market fragmentation. The model also generates the Linder hypothesis from the supply side, and the Balassa-Samuelson e¤ect. Finally, trade partner characteristics do a¤ect the level of competition in the host country when quality choice is taken into consideration