Dynamic Duopoly Competition with Switching Costs and Network Externalities

Abstract

This paper analyzes competition in a two-period differentiated-products duopoly in the presence of both switching costs and network effects. We show that they have opposite implications on the demand side, specially in the first period. Switching costs reduce demand elasticities and network effects increase them. We derive the symmetric subgame perfect equilibrium outcome of the two-period competition. An increase in marginal network benefits implies lower prices in both periods while the effect of an increase switching costs is ambiguous. We show that the first-period equilibrium prices are U-shaped in switching costs and decrease when switching costs increase around zero. Furthermore, we show that prices in a market with network effects and switching costs may be lower than those in a market without these features, with only switching costs and with only network effects.