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Product quality and product compatibility in network industries

Author

Listed:
  • Domenico Buccella
  • Luciano Fanti
  • Luca Gori

Abstract

Making use of an appropriate game-theoretic approach, this article develops a two-stage game in a Cournot duopoly in network industries, in which firms strategically choose whether to produce compatible goods. Quality differentiation significantly affects the sub-game perfect Nash equilibrium (SPNE) of the game: (i) the network effect acts differently between low- and high-quality firms depending on their compatibility choice; (ii) the unique SPNE is to produce compatible (resp. incompatible) goods if the network externality is positive (resp. negative); however, this equilibrium can be Pareto inefficient, and the high-quality firm is worse off; (iii) there is room for a side payment from the high- to the low-quality firm to deviate towards incompatibility (resp. compatibility) under positive (resp. negative) network externality. The social welfare outcomes corresponding to the SPNE are also pinpointed.

Suggested Citation

  • Domenico Buccella & Luciano Fanti & Luca Gori, 2023. "Product quality and product compatibility in network industries," Discussion Papers 2023/291, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
    • Handle: RePEc:pie:dsedps:2023/291
    Note: ISSN 2039-1854
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    File URL: https://www.ec.unipi.it/documents/Ricerca/papers/2023-291.pdf
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    More about this item

    Keywords

    Network externality; Product compatibility; Cournot duopoly; Quality differential;
    All these keywords.

    JEL classification:

    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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