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Essays on infrastructure development subsidization by product firms

Vildan Altuglu, 2005
Faculty Advisor: Donald Lehmann
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Sales of radically new products and technological innovations in most instances depend on the development of an associated infrastructure. Infrastructure, as utilized in this thesis, is the development of supporting products, services and systems to capitalize on the adoption of an innovation. Infrastructure development can accelerate product growth, whereas its absence can hinder growth.

The main focus of this research is to examine the markets in which infrastructure has an expansionary effect on the demand for a new product and the market behavior of firms in these markets. Of special interest is determining whether and how much product manufacturers invest in infrastructure development.

Models of infrastructure development and market expansion effects are developed using two distinct approaches. The first approach utilizes a Bass diffusion model framework. Infrastructure effects are incorporated into the market potential term of the Bass diffusion model. The optimal infrastructure development level for a monopolist is determined in a two-period setting using different functional forms.

The second approach utilizes a product differentiation model in a monopolistic competition setting. In this setting, two product manufacturers compete in the product market whereas there is a monopoly in the infrastructure market. The positive effects of infrastructure development are incorporated into the model by the use of interdependent demand functions. The conditions under which the product manufacturers subsidize the infrastructure firm are determined.

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