Quality , Upgrades , and ( the Loss of ) Market Power in a Dynamic Monopoly Model July 2008

1 Anton: [email protected]; Biglaiser: [email protected]. We are grateful to the Fuqua Business Associates Fund and Microsoft for …nancial support. We thank Harvard Business School, the Portuguese Competition Authority, and UCSD for their hospitality where some of this research was conducted. We also thank Leslie Marx, Jean Tirole, many colleagues at conferences and seminars, and, especially, Joel Sobel for many helpful conversations. The views in this work are solely are own. Abstract We examine an in…nite horizon model of quality growth in a durable goods monopoly market. The monopolist generates new quality improvements over time and can sell any available qualities, in any desired bundles, at each point in time. Consumers are identical and for a quality improvement to have value the buyer must possess previous qualities: goods are upgrades. We …nd that the upgrade structure, quality growth, and the fact that consumers are always in the market can lead to an almost complete loss in market power for the seller even though all consumers are identical. This is true for all discount factors. We show that subgame perfect equilibrium payo¤s for the seller range from capturing the full social surplus all the way down to capturing only the current ‡ow value of each good and that each of these payo¤s is realized in a Markov perfect equilibrium that follows the socially e¢ cient allocation path. We also …nd that equilibria may be ine¢ cient.