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Information Technology Phones, Faxes, , 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?

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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 n*v, where n is the number of persons who buy the good.

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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 = v. So inverse demand is p = n(1000-n). Graph this! What is the supply curve if marginal cost c<250,000?

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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.

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Discussion points Competitors: VHS vs. Beta, Qwerty vs. Dvorak, Windows vs. Mac, Playstation vs. Xbox, Blue-ray vs. HD-dvd. 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 Lots of networks: Religions and Languages.

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Homework. Students like to go to the Haifa Ball depending upon how many other students go there. Tickets cost 32 NIS each. There are 1000 students indexed by i from 1 to Student i has value vi=i. Student i has utility (in shekels) for going to the Ball of vi (n/(5000)), where n is the total number of students going to the Ball. (i) If everyone believes n=500, which students will be willing to go to the ball? (ii) What is the threshold number of tickets sold above which it will be a success and below which it will be a failure? (iii) What is the equilibrium of tickets sold if the ball is a success? (iv) What is the equilibrium of tickets sold if the ball is a failure?

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