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Optimal Technology Adoption Subsidies with Consumer Switching Costs and Strategic Firms

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Document pages: 40 pages

Abstract: This analytical modeling paper investigates optimal subsidies to promote adoption of a socially beneficial new technology in a market with consumer switching costs and strategic firms. For the firms, it explores the pricing decisions of an entrant selling the new technology and an incumbent selling an established technology. For the government, it analyzes optimal subsidies for old and new customers who are distinguished by switching costs. Academically, this paper makes a novel and important connection between the literature on optimal subsidies and switching costs. I assess how the firms’ ability to price discriminate, and the government’s ability to engage in policy segmentation, between old and new customers affect optimal subsidies and welfare outcomes. Practically, this paper is relevant to governments attempting to diffuse green technologies such as solar panels and electric vehicles, and to firms in these industries. The model represents a duopoly with an entrant and incumbent selling horizontally differentiated products to both old customers, who face switching costs to adopt the new technology, and new customers, who do not. Given subsidies, I characterize equilibrium prices, market shares, and profits when the firms can and cannot price discriminate. Then, I analytically determine the optimal subsidy levels for old and new customers when the government can and cannot segment them. The only scenario with lower maximum achievable social welfare than the others occurs when firms can price discriminate but the government cannot set different subsidy levels for old and new customers. Although the government can overcome the effects of price discrimination, doing so requires the ability to practice policy segmentation and higher government expenditures on the subsidy program. Policymakers should find it easier and less costly to improve welfare through adoption subsidies if they can prevent price discrimination based on switching costs.

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