Pricing to market, firm heterogeneity and the role of quality

We build a pricing-to-market (PTM) model with firm heterogeneity, 9 which allows for imperfect competition and market segmentation in the presence of 10 flexible exchange rates, horizontal and vertical differentiation and different tastes of 11 consumers in destination markets. We derive firm’s pricing behaviour in response to 12 price and quality competition shocks. We show that there is PTM heterogeneity 13 across firms if quality has a role. We empirically assess the main predictions of our 14 theoretical framework on Italian firm-level data. We document that export-domestic 15 price margins are significantly affected by price and quality competitiveness factors 16 even controlling for foreign demand conditions, size, export intensity, destination 17 markets and unobservables. Finally, we provide evidence of strong heterogeneity 18 across firms in their reaction to price and quality competitiveness.