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Information Technology
• Phones, Faxes, e-mail, etc. all have the following
property:
– Network externalities: The more people using it the
more benefit it is to each user.
• Computers, VCRs, PS2s, also have this property
in that both software can be traded among users
and the larger the user market, the larger number
of software titles are made.
• How do markets operate with such externalities?
Competition & Network
Externalities
• Individuals 1,…,1000 (call this number v)
• Each can buy one unit of a good providing a
network externality.
• Person v values a unit of the good at nv,
where n is the number of persons who buy
the good.
Competition & Network
Externalities
• What is the demand at price p?
• If v is the marginal buyer, valuing the good
at nv = p, then all buyers v’ > v value the
good more, and so buy it.
• Quantity demanded is n = 1000 - v.
• So inverse demand is p = n(1000-n).
• Graph this!
• What is the supply curve if marginal cost
c<250,000?
Competition & Network
Externalities
• What are the market equilibria?
• Zero.
• A large numbers of buyers buy.
– large n*  large network externality value n*v
– good is bought only by buyers with n*v  c; i.e.
only large v  v* = c/n*.
• The other point is unstable and called a threshold
point. Below this, demand will go to zero. Above
this, the product would be a hit.
Discussion points
• Competitors: VHS vs. Beta, Qwerty vs. Dvorak,
Windows vs. Mac, Playstation vs. Xbox.
• Does the best always win?
• Standardization helps with network externalities.
– Drive on left side vs. right side. Out of 206 countries
144 (70%) are rhs.
– Left is more nature for an army: swords in right hand,
mounting horses. (Napolean liked the other way.)
– Sweden switched from left to right in 1967.
• Lots of networks: Religions and Languages.