Welfare-Deteriorating Construction of Public Infrastructure

Abstract

This study examines an extension of the Hotelling model of spatial competition in which there are two separated linear cities with two roads connecting them at the edges of the cities. Initially, the cost of passing them for consumers is too high so they are impassible, but one of them is improved and passible. This simple setting gives an asymmetric set of Nash equilibria which has not been discussed in the literature before. Further, it leads to the counterintuitive result that, under reasonable assumptions, connecting the two cities decreases social welfare, even when the cost of doing so is zero. Moreover, improving two roads simultaneously may recover social welfare.

Keywords: Spacial Competition, Hotelling's Model, Duopoly

JEL Classification: D21, D43