Long-run market configurations in a dynamic quality-ladder model with externalities

Abstract

We study the impact of standard-setting by introducing an externality that increases product compatibility in the presence of asymmetric returns to investment in a dynamic quality-ladder-type model. We classify the long-run, multi-modal probability distributions over different market structures that arise from this model. In some cases, the lagging firm may remain in the market in the long-run depending on the strength of the externality. In the case where only the laggard invests in compatibility, it is possible that the laggard becomes a monopolist if the leader has a relatively low R&D capability and the two firms are almost symmetric in this same regard. This variety of multi-modal long-run distributions may have important consequences for the estimation and the simulation of this class of dynamic models.