R&D for Quality Improvement and Network Externalities

We investigate the bearings of network externalities on product quality improvements requiring costly R&D investments. The model considers the dynamic behaviour of a monopolist alternatively maximising profits or social welfare. On the one hand, we confirm much of the acquired wisdom from the static literature on the same topic, about the arising of quality undersupply at the private optimum. On the other, we show that the monopoly optimum requires specific viability conditions, while the social optimum is always viable. We also show that the presence of network externalities affects the optimal investment behaviour of the profit-seeking firm but not that of a benevolent planner, who serves all consumers from the outset.