DYNAMIC ANALYSIS OF PRODUCT AND PROCESS INNOVATION FOR A PRICE-REGULATED FIRM IN A MARKET EXHIBITING NETWORK EXTERNALITY

In this article, we investigate the dynamic control problems of a price-regulated monopolist's product innovation (improving product quality) and process innovation (reducing marginal production cost) in a market exhibiting network externality. Our work significant features are: (i) the price of the product is regulated, which is set by a regulator, who links price level to the product quality; (ii) extending the research on product and process innovation by considering reference quality in which reference quality is a dynamic variable; (iii) the consumers' demand function depends on product price, product quality, and reference quality; and (iv) the network size is proportional to consumers' demand. Our main results show that: (i) under monopoly and social planning, there exists a unique saddle-point steady-state equilibrium, respectively; (ii) in the neighbourhoods of steady-state equilibrium, the social incentive towards both the investments in product and process innovation is always larger than the private incentive characterising the profit-seeking monopolist; (iii) although the price is regulated, the price is higher under social planning than that under monopoly; (iv) the monopolist undersupplies product quality as compared to the social planning, while marginal production cost is socially efficient.