1. 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?

2. 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.

3. 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?

4. 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.

5. 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.