Consumer Conformity and Vanity in Vertically Differentiated Markets
Hend Ghazzai

Abstract
Consumers' choice of a good may be motivated by the wish to belong to some group or the search for exclusiveness. Such behavior gives rise to either positive or negative consumption externalities. Although, these externalities are very important in several markets, their impact on firms' quality choice in vertically differentiated markets has not been yet explored. We study firms' decisions in terms of prices and qualities when consumers' utility is affected by the number of consumers who buy the same quality and also partially affected by the number of consumers who buy close qualities. The market outcomes are significantly affected as the low quality firm may prefer to stay out of the market when the consumption externality is strong. Moreover, under some conditions on the strength of the consumption externality and on consumers' sensitivity to firms' quality difference, we prove that product differentiation may not be maximal as in the standard model.

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