Consumer Investment in Product-Specific Capital: The Monopoly Case

Abstract

For many pairs of complementary products, one good might usefully be called a consumption good, and the other a capital good. A concrete example of such complements is gasoline and automobiles. Because of complementarity, investment in automobiles depends on the price of gas. Since cars bought today will be around for several years, there is a dynamic link between the current price of gas and future demand for gas. OPEC has a strategic incentive to set a low oil price today since a low price promotes investment in big cars and other oil-fueled equipment which, in turn, increases the future profit of the oil industry. Consumer investment in product-specific capital is a feature of the markets for many products, especially if one takes a broad perspective of what this capital decision can be. For instance, continuing the example of the gas market, the decision to reside far from work is analogous to the decision to buy a big car since (1) the decision may be influenced by the current price of gas and (2) the decision affects an individual's future demand for gas. As another example consider the demand for phone service. In response to a low price of phone service, businesses makes capital decisions such as the purchase of computer telemarketing machines and other phone equipment. The businesses may also configure their marketing strategy to use (human) phone contact rather than direct personal contact, and such a strategy involves investment in human capital. These investment decisions all tend to make the future demand for phone service relatively inelastic. This paper presents a model in which there are capital goods, cars, which can be used for two periods, and a consumption good, gas, which fuels the cars. Big cars are gas guzzlers; i.e., car size and gas are complements. Consumers select the size of their car on the basis of the current price of gas and their expectations of the future