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Vertical Product Differentiation, Network Externalities, and Compatibility Decisions

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Anette Boom ()
Pio Baake

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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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Paper provided by Departmental Working Papers in its series Papers with number 010.

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Find related papers by JEL classification:
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection

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  1. Nicholas Economides & Fredrick Flyer, 1997. "Compatibility and Market Structure for Network Goods," Working Papers 98-02, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
  2. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August. [Downloadable!] (restricted)
  3. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June. [Downloadable!] (restricted)
  4. Belleflamme, Paul, 1998. "Adoption of network technologies in oligopolies," International Journal of Industrial Organization, Elsevier, vol. 16(4), pages 415-444, July. [Downloadable!] (restricted)
  5. Farrell, Joseph & Saloner, Garth, 1992. "Converters, Compatibility, and the Control of Interfaces," Journal of Industrial Economics, Blackwell Publishing, vol. 40(1), pages 9-35, March. [Downloadable!] (restricted)
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  6. Navon, Ami & Shy, Oz & Thisse, Jacques-François, 1995. "Product Differentiation in the Presence of Positive and Negative Network Effects," CEPR Discussion Papers 1306, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  7. Baake, Pio & Boom, Anette, 2001. "Vertical product differentiation, network externalities, and compatibility decisions," International Journal of Industrial Organization, Elsevier, vol. 19(1-2), pages 267-284, January. [Downloadable!] (restricted)
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  1. GABSZEWICZ, Jean J. & GARCIA, Filomena, 2005. "Quality improvement and network externalities," CORE Discussion Papers 2005096, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
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  2. Fabio M. Manenti & Ernesto Somma, 2002. "One-Way Compatibility, Two-Way Compatibility and Entry in Network Industries," Industrial Organization 0205001, EconWPA, revised 04 Oct 2002. [Downloadable!]
    Other versions:
  3. Rossella Argenziano, 2007. "Differentiated Networks: Equilibrium and Efficiency," Economics Discussion Papers 638, University of Essex, Department of Economics. [Downloadable!]
    Other versions:
  4. Hend Ghazzai & Rim Lahmandi-Ayed, 2006. "Vertical differentiation, network externalities and compatibility decisions : an alternative approach," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00111166_v1, HAL. [Downloadable!]
    Other versions:
  5. Kemppainen, Kari, 2008. "Integrating European retail payment systems: some economics of SEPA," Research Discussion Papers 22/2008, Bank of Finland. [Downloadable!]
  6. Ralph C Bayer & Mickey Chan, 2004. "Network Externalities, Demand Inertia and Dynamic Pricing in an Experimental Oligopoly Market," Experimental 0412004, EconWPA. [Downloadable!]
    Other versions:
  7. Klaus Conrad, . "Network effects, Compatibility and the Environment: The Case of Hydrogen Powered Cars," IVS discussion paper series 613, Institut für Volkswirtschaft und Statistik (IVS), University of Mannheim. [Downloadable!]
  8. Anette Boom & Pio Baake, . "Vertical Product Differentiation, Network Externalities, and Compatibility Decisions," Papers 010, Departmental Working Papers. [Downloadable!]
    Other versions:
  9. Sääskilahti, Pekka, 2006. "Buying Decision Coordination and Monopoly Pricing of Network Goods," MPRA Paper 5106, University Library of Munich, Germany. [Downloadable!]
  10. Vries, H.J. de & Hendrikse, G.W.J., 2001. "The Dutch Banking Chipcard Game," Research Paper ERS-2001-18-ORG Revision_, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
  11. Amihai Glazer & Hiroki Kondo, 2007. "Innovation and Imitation Across Jurisdictions," Working Papers 070807, University of California-Irvine, Department of Economics. [Downloadable!]
  12. Claudia Salim, 2009. "Platform Standards, Collusin and Quality Incentives," Discussion Papers 257, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich. [Downloadable!]
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