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Discussion Paper Details

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Title: Investment Dynamics in Markets with Endogenous Demand

Author(s): Nikolaos Vettas

Publication Date: November 1998

Keyword(s): diffusion paths, infant industries, Network Externalities, New products and Path Dependence

Programme Area(s): Industrial Organization

Abstract: In several interesting markets, demand is an increasing function of past sales because of learning, network externalities or fashion. This paper examines entry into such markets. The two key elements of the model are that firms are uncertain about the demand (and learn in a Bayesian fashion) and that demand grows endogenously over time. The capacity expansion path of the competitive market is compared with the planning/monopoly solution. These paths differ not only with respect to levels (the market's investment is too low), but also with respect to their time patterns (externalities may lead to S-shaped diffusion). This framework provides some justification for industrial or trade policy arguments for subsidizing entry into new markets, especially for infant-export industries. The markets examined also exhibit path-dependence: small initial differences in demand conditions may lead either to an established market or a non-existing one.

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Bibliographic Reference

Vettas, N. 1998. 'Investment Dynamics in Markets with Endogenous Demand'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=1994