Infrastructure Investment with Public and Private Product Development

Private firms often develop new products by utilizing substantial infrastructure investments made by government agencies. We construct a mixed oligopoly model to study the interactions between the government’s infrastructure quality decision and the subsequent public and private product development decisions. We have five main results: First, the government permits firm entry in the product market only when the firm is sufficiently more efficient at product development than the government. With firm entry, the government invests more in developing infrastructure because the firm’s presence increases the government’s return on investment in infrastructure. Second, the quality received by the consumer might improve or worsen in the presence of a private firm, depending on the relative product development efficiency as well as the cost of infrastructure development. Third, private presence can lead to a significant reduction in consumer surplus, especially at the lower end of the market. This happens when infrastructure investment cost is high, because the small increase in infrastructure quality with firm entry is not enough to compensate for the reduction in the government’s product quality. Fourth, depending on the relative product development efficiency of the private firm, the government might implement policies that prevent the private firm from entering the market. Finally, there exist circumstances under which private presence can be beneficial in that it leads to products that not only enhance social welfare but also improve overall consumer surplus.