This paper presents a theoretical and empirical study of price formation in markets where goods differ in two attributes, namely the perceived quality of each variety, and the service provided by the store where the good is sold. Price competition in the vertically differentiated market is modeled as a two-stage game where manufacturers choose the contract that determines wholesale prices, and retailers choose consumer prices. One important novelty of the paper is that it contemplates competition between brands of different qualities in the same store, and competition between brands of the same quality sold at different stores. This is in fact the situation observed in the domestic detergent market and the predictions of the model can be used to guide the empirical analysis of the data available for such a market in the Barcelona area of Spain.

Keywords: price formation, product differentiation, vertical relations.
JEL classification: L2