Dynamic Innovation in a Two-Sided Platform

We are interested in a two-sided platform, in which dynamic innovation plays a role in stimulating consumer demand that also drives firms´ incentive to innovate. By explicitly modeling the price competition within the two-sided market, we study ways consumers´ platform fee interacts with firms´ pricing strategies on the platform. Our framework also characterizes a dynamic R&D race and solves the stationary Markov equilibrium using computation methods. We find that by charging consumers a fee, the platform is not necessarily better off, because firms may subsidize this cost by lowering their prices in the market, which leads to lower transaction revenues and innovation rate. Platform´s revenues may also suffer if it shares firms´ transaction revenues. Surprisingly, despite the platform fee, consumer welfare improves as a result of lower prices. However, these effects are not monotonic, and shifts in the opposite direction occur when firms switch to different pricing strategies, because consumers´ platform fee also mitigates price competition between low- and high-quality firms.