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The B.E. Journal of Economic Analysis & Policy

Editor-in-Chief: Jürges, Hendrik / Ludwig, Sandra

Ed. by Auriol , Emmanuelle / Brunner, Johann / Fleck, Robert / Mendola, Mariapia / Requate, Till / Zulehner, Christine / Schirle, Tammy

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Incentives to Invest in Transport Cost Reduction - Conceptual Issues and an Application to Electronic Commerce

Martin Bandulet1 / Karl Morasch2

1Universität Augsburg,

2Universität der Bundeswehr München,

Citation Information: Topics in Economic Analysis & Policy. Volume 3, Issue 1, ISSN (Online) 1538-0653, DOI: 10.2202/1538-0653.1099, December 2003

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Do firms have proper incentives to invest in transport cost reduction? We discuss this question in a duopoly with a local firm and a distant competitor that may invest in a reduction of marginal transportation costs. In a two-stage game with investment in the first and duopoly competition in the second stage, we compare profit-maximizing investment with (constrained) welfare maximization by a social planer. Intuitively, a firm will overinvest if the negative impact on its competitor exceeds the gain in consumer surplus. We analyze how the relative strength of these two effects depends on market demand, firm conduct and investment costs. Applying our results to electronic commerce, we argue that for physical goods either overinvestment or the efficient decision not to invest is the most likely outcome while the specific characteristics of digital products yield either underinvestment or an efficient investment level that reduces transportation costs to zero.

Keywords: Electronic markets; Strategic investment; Transport costs

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