Vertical product differentiation,network externalities,and compatibility decisions |
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| Affiliation: | 1. Research School of Economics, College of Business and Economics, Australian National University, HW Arndt Building 25A, Australian National University, Canberra, ACT 2601, Australia;2. Visitor, Department of Economics, University of California, Los Angeles, 9242 Bunche Hall, Los Angeles, CA 90095;3. School of Economics, Renmin University of China, Beijing 100872, China |
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| Abstract: | We analyse the subgame perfect equilibrium of a four-stage game in a model of vertical product differentiation, where the consumer’s evaluation of a product depends on its inherent quality and on its network’s size. First, two firms choose their product’s inherent quality. Then they may mutually agree on providing an adapter before competing in prices. Finally, consumers buy. We find that, despite the high quality firm’s preference for incompatibility, an adapter is always provided in equilibrium. Social welfare is greater than without an adapter and can be improved by regulating compatibility only in those cases where qualities are differentiated too much. |
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