Price and Quality Dynamics in Export Markets

This paper investigates the evolution of firm-level price and quality decisions in export markets. We develop a model of heterogeneous firms which endogenously choose their optimal price and product quality to build demand in each export market. Consistent with existing research, more productive firms produce higher quality products, charge higher prices, sell more units and achieve higher profits. In our model, however, product quality and prices endogenously evolve over time as firms accumulate demand in each market and maximize the long-run value of the firm. We find that new exporters optimally charge relatively low prices and produce low quality goods upon initial entry into export markets. As sales grow exporters upgrade product quality and increase prices in response to greater demand. We structurally estimate the model using detailed Chinese customs data. Our results indicate that the incentive to build future demand reduces export prices upon initial entry by 0.5 percent for the average exporter. Over the following five years, export prices and product quality are estimated to grow by 1 and 6 percent, respectively, due to endogenous demand accumulation.