Entry to New Markets with Endogenous Demand

In several interesting markets, demand is an increasing function of past sales, because of learning, network externalities, or "fashion." This paper examines entry into such markets where demand is initially unknown to the firms but grows endogenously over time. The capacity expansion paths of the competitive market is compared with the planning/monopoly solution. These paths differ not only with respect to levels (the market's investment is too low) but also their shapes (S-shaped diffusion is more likely to be observed in competitive markets). This framework provides some justification for industrial or trade policy arguments for subsidizing entry to new markets, especially for infant-export industries. The markets examined also exhibit path-dependence: small initial differences in demand conditions may lead either to an established market or a non-existing one.