Working Paper: CEPR ID: DP3815
Authors: Uwe Walz; Bernd Woeckener
Abstract: We analyse the compatibility decisions of two national firms producing horizontally differentiated variants of a good that exhibits network effects for the world market. One of the firms is able to endogenously establish an installed base in its domestic market. The firm's effort in that respect is reinforced by a production subsidy that covers the firm's domestic market. With the help of a three-country model we ask under which circumstances this local subsidy may be and actually is used as a strategic trade-policy device. We show that the installed-base effect plays a role only when the firms opt for incompatibility. In addition, we obtain the result that only for intermediate values of the network-effect parameter incompatibility is chosen. In all other cases, compatibility emerges and so the local subsidy can be shown to increase world welfare.
Keywords: compatibility decisions; standards; strategic trade policy
JEL Codes: F12; F13; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| local subsidy (H23) | installed base (Y20) |
| installed base (Y20) | competitive position of domestic firm (F23) |
| competitive position of domestic firm (F23) | world market competition (L13) |
| local subsidy (H23) | pricing strategies (D49) |
| local subsidy (H23) | market shares (L17) |
| network effect parameter (D85) | incompatibility (L15) |