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Cost Reduction can Decrease Pro t and Welfare in a Monopoly

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  • Ryoma Kitamura

    (Graduate School of Economics, Kwansei Gakuin University)

Abstract

This paper develops a monopoly model in which two vertically differentiated goods are supplied and involve a within-product network externality. Within this model, I examine how the cost of the high-quality good affects the firm’s profit and welfare, demonstrating a surprising result that both the profit and welfare are U-shaped in the cost and thus, in particular, a decrease in the marginal cost can reduce the monopoly profit. I show that the assumptions of the fulfilled expectations equilibrium and multi-product monopoly lead to this counter intuitive possibility. Furthermore, changes in production costs and in quality yield cannibalization such that the consumption of one good increases while that of the other decreases.

Suggested Citation

  • Ryoma Kitamura, 2015. "Cost Reduction can Decrease Pro t and Welfare in a Monopoly," Discussion Paper Series 133, School of Economics, Kwansei Gakuin University, revised Jul 2015.
    • Handle: RePEc:kgu:wpaper:133
    as

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    File URL: http://192.218.163.163/RePEc/pdf/kgdp133.pdf
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    References listed on IDEAS

    as
    1. 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.
    2. Anindya Ghose & Michael D. Smith & Rahul Telang, 2006. "Internet Exchanges for Used Books: An Empirical Analysis of Product Cannibalization and Welfare Impact," Information Systems Research, INFORMS, vol. 17(1), pages 3-19, March.
    3. Barrett, Christopher B. & Yang, Yi-Nung, 2001. "Rational incompatibility with international product standards," Journal of International Economics, Elsevier, vol. 54(1), pages 171-191, June.
    4. Preyas S. Desai, 2001. "Quality Segmentation in Spatial Markets: When Does Cannibalization Affect Product Line Design?," Marketing Science, INFORMS, vol. 20(3), pages 265-283, August.
    5. Lahiri, Sajal & Ono, Yoshiyasu, 1988. "Helping Minor Firms Reduces Welfare," Economic Journal, Royal Economic Society, vol. 98(393), pages 1199-1202, December.
    6. Haruvy, Ernan & Prasad, Ashutosh, 1998. "Optimal product strategies in the presence of network externalities," Information Economics and Policy, Elsevier, vol. 10(4), pages 489-499, December.
    7. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-440, June.
    8. Shy,Oz, 2001. "The Economics of Network Industries," Cambridge Books, Cambridge University Press, number 9780521800952.
    9. Hahn, Jong-Hee, 2003. "Nonlinear pricing of telecommunications with call and network externalities," International Journal of Industrial Organization, Elsevier, vol. 21(7), pages 949-967, September.
    10. Ryoma Kitamura & Tetsuya Shinkai, 2013. "The Economics of Cannibalization: A Duopoly in which Firms Supply Two Vertically Differentiated Products," Discussion Paper Series 100, School of Economics, Kwansei Gakuin University, revised Feb 2013.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Multi-product firm; Monopoly; Cannibalization; Network externality;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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