Consumption Externalities and Product Quality: The Market for Military Hardware

This paper considers arms race between to rival nations and arms trade between these buyer countries and a number of producers. All the parties are completely informed, and the sellers manufacture differentiated products. It is shown that intensified competition among the producers leads the buyer countries to step up their military buildup but has no effect on the buyers’ national welfare if they have symmetric demand for arms. We also find the conditions under which increased competition among the sellers induces all of them to produce goods of higher qualities in equilibrium.