- September 2015
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- This paper analyzes the interplay between endogenous quality choice and the market power of trade unions. In a unionized duopoly downstream firms face a trade-off. They choose either to differentiate production to relax final market competition (this pushes wages up), or to reduce it to induce a fiercer upstream competition (pushing wages down). In this way, the degree of product differentiation becomes a valuable tool for downstream firms. When upstream market power is weak, downstream firms do not care about wages and differentiate their products. But as soon as unions' bargaining power increases, wages also increase and downstream firms choose less quality differentiation to reduce them. Thus, the higher the bargaining power of trade unions, the lower the quality gap. This result emerges more strongly when downstream firms merge, and it is robust to the type of competition and the nature of costs.