Barriers to network-specific innovation
We consider an environment in which participants make payments over a network and can invest in a technology that reduces the marginal cost of using the network. A network effect results in multiple equilibria; either all agents invest and usage of the network is high or no agents invest and usage of the network is low. The high-usage equilibrium can be implemented through introduction of a coordinator. Under monopoly network ownership, however, fixed costs associated with use of the network-specific technology result in a hold-up problem that implements the low-investment equilibrium. And even where subsidies can avoid such hold-up, optimal monopoly pricing of network usage may avoid investment in the network-specific technology if demand for on-network transactions is sufficiently inelastic.
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