R&D investment and network effects: A dynamic model of the search engine market

Abstract

ABSTRACT This paper considers R&D investment for quality improvement in a dynamic duopoly game in the search engine market. The aim is to determine the circumstances under which asymmetry between search engines (in terms of quality) tends to increase or decrease over time. I show that when the future sufficiently matters, the low-quality search engine can catch up with the high-quality engine by investing in quality. In contrast, when only the present matters, the high-quality search engine wins and the structure of the market transitions to a monopoly. I also show that a shift in asymmetry between firms can result in either an increase or decrease in consumer welfare, depending on the degree of substitutability between the two search engines.