R&D in Markets with Network Externalities

Abstract

We study how network externalities affect research and development (R&D) investments by a non-cooperative duopoly that offers compatible products. We find that multiple R&D equilibria may arise when network externalities are non linear in the number of consumers. The lowest R&D equilibrium corresponds to the case where network externalities are absent. However, even in the presence of network externalities, firms may be trapped in a low-R&D equilibrium where output, and therefore consumers' valuation of the network size, is low. We derive the conditions under which the highest-R&D equilibrium Pareto dominates.Network Externalities