Product Compatibility Choice in a Market With Technological Progress*

In markets where advantages, e.g., network ex ternalities, are significant, firms' product compatibility choices are an import ant determinant of industry performance. This paper compares the private and soc ial incentives to achieve compatibility in a two-period duopoly model with (poss ible stochastic) technological progress. Earlier analysis using static models fo und that the social incentives to achieve industrywide compatibility always exce ed the private incentives. Here the authors find that private firms may have soc ially excessive compatibility incentives because compatibility serves as a means of relaxing price competition during early stages of industry growth.