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ECON0123 Weeks 8-9
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Weeks 8 and 9Markets with network goods
BP Ch20 and 21
Network effects
A product exhibits network effects if each user’s payoff is increasing in the number of other users
of that product or of comparable products
Network effects are observed in two types of markets:
• Network or communication markets
◦ The benefit of consumers comes form the ability to communicate with other consumers via
the network
◦ Direct network effects: more agents in the network —> more communication opportunities—
> more incentives to join the network
• System markets
◦ Products are obtained by combining components in a complementary way
◦ Indirect network effects: more users of the system —> more developers desire to write
applications for the system —> more incentives for users to buy the system
And switching costs
Switching costs, SC- consumers value compatibility between their purchases
Network effects, NE- consumers value compatibility with others’ purchases
• Network markets- network effects are a cause of switching costs
◦ Early choices tend to commit later users, creating a form of collective switching costs
• System markets - network effects are a consequence of switching costs
◦ When choosing between competing systems, consumers prefers the one offering the largest
(current and future) availability of applications
◦ This depends on the number of consumers who adopt the system in question only if there
are switching costs between systems
◦ These depend on the compatibility between systems
Compatibility may induce lock in, generating ex post rents for sellers
• SC- sellers can extract a rent close to the consumer’s switching costs
• NE- The larger the network, the larger the price the network owner can charge to users
The locus of competition is different
• SC- Competition concerns streams of products or services
• NE- Competition concerns selling to large groups of users
Competition focuses on early adoptions - ex ante it is difficult to reap ex post rents created once
consumers are locked in
, Modelling
NETWORKGOOD SYSTEM GOOD
standalonebenefit
Vijaitgilmil aitgifhlng.lt
I
Vij dit MI nousers
p redicted
nocompatible
applications
am
Interdependences
Entry:
• Given quality levels, sellers decide whether to enter
• If sellers offer more distinct products, buyers enjoy more variety
• Entry decision depends on the number of active users
• User’s utility is increasing in variety
Quality:
• Seller investment in quality depends on active number of buyers
• Users utility is increasing in product quality
Eg.
Rnousersofconsole
gqualityofgames Stuka
developersinvestment Mls 1 clock
Xshareof n't sk 2n7Viaitll7112n7
my2nA
by
taken developer
benefits Developer x sock
quality
depends
onn
Expectations
Two approaches:
• Fulfilled expectations- assume that consumers rely on their expectations about future network
sizes (equilibrium when expectation turns out to be correct)
• Myopic expectations- assume that consumers base decisions on the current network size
Consumer’s heterogeneity
AIMMON
Uniquenetwork
good
Oe0,1 consumer'stasteparameter adoptersh avelaged
early
filne vineViO
Spredictedn
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