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Bertrand Competition in Markets with Network Effects and Switching Costs

  • Irina Suleymanova
  • Christian Wey

We analyze market dynamics under Bertrand duopoly competition in industries with network effects and consumer switching costs. Consumers form installed bases, repeatedly buy the products, and differ with respect to their switching costs. Depending on the ratio of switching costs to network effects, our model generates convergence to monopoly as well as market sharing as equilibrium outcomes. Convergence can be monotone or alternating in both scenarios. A critical mass effect, where consumers are trapped into one technology for sure only occurs for intermediate values of switching costs, whereas for large switching costs market sharing is the unique equilibrium and for small switching costs both monopoly and market sharing equilibria emerge. We also analyze stationary and stable equilibria, where we show that a monopoly outcome is almost inevitable, if switching costs or network effects increase over time. Finally, we examine firms' incentives to make their products compatible and to create additional switching costs.

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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 796.

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Length: 56 p.
Date of creation: 2008
Date of revision:
Handle: RePEc:diw:diwwpp:dp796
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  1. Rossella Argenziano, 2007. "Differentiated Networks: Equilibrium and Efficiency," Economics Discussion Papers 638, University of Essex, Department of Economics.
  2. Beggs, Alan & Klemperer, Paul, 1990. "Multi-Period Competition with Switching Costs," CEPR Discussion Papers 436, C.E.P.R. Discussion Papers.
  3. Irina Suleymanova & Christian Wey, 2008. "On the (Mis-) Alignment of Consumer and Social Welfare in Markets with Network Effects," Discussion Papers of DIW Berlin 794, DIW Berlin, German Institute for Economic Research.
  4. Angelique Augereau & Shane Greenstein & Marc Rysman, 2006. "Coordination versus differentiation in a standards war: 56K modems," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 887-909, December.
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  12. Grilo, Isabel & Shy, Oz & Thisse, Jacques-Francois, 2001. "Price competition when consumer behavior is characterized by conformity or vanity," Journal of Public Economics, Elsevier, vol. 80(3), pages 385-408, June.
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  15. Neil Gandal, 2002. "Compatibility, Standardization, and Network Effects: Some Policy Implications," Oxford Review of Economic Policy, Oxford University Press, vol. 18(1), pages 80-91, Spring.
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  19. David, Paul A, 1985. "Clio and the Economics of QWERTY," American Economic Review, American Economic Association, vol. 75(2), pages 332-37, May.
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