Durable goods oligopoly with innovation: theory and empirics

Survey of Current Business, March, 2008

Ronald Goettler (Carnegie Mellon) and Brett Gordon (Columbia). Discussant: Ana Aizcorbe.

This paper proposes a model of dynamic oligopoly and applies it to the microprocessor industry. Our findings highlight the "competing-with-itself" aspect of being a monopolist of a durable good: the monopolist must innovate to stimulate demand through upgrades. The benefit is higher for the monopolist because its substantial pricing power enables it to extract much of the innovation-generated surplus. We also show that prices and profits are much higher when firms correctly account for the dynamic nature of demand, compared with an alternative scenario in which they ignore the effect of current prices on demand. Finally, equilibrium prices, profits, innovation, and consumer surplus are all increasing in the consumer's discount factor. Higher discount factors imply higher discounted flow utility from the durable good, which raises the consumer's willingness-to-pay.