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Chapter 4Slide 1 Network Externalities Up to this point we have assumed that peoples demands for a good are independent of one another. If fact, a persons.

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Presentation on theme: "Chapter 4Slide 1 Network Externalities Up to this point we have assumed that peoples demands for a good are independent of one another. If fact, a persons."— Presentation transcript:

1 Chapter 4Slide 1 Network Externalities Up to this point we have assumed that peoples demands for a good are independent of one another. If fact, a persons demand may be affected by the number of other people who have purchased the good.

2 Chapter 4Slide 2 Network Externalities If this is the case, a network externality exists. Network externalities can be positive or negative.

3 Chapter 4Slide 3 Network Externalities A positive network externality exists if the quantity of a good demanded by a consumer increases in response to an increase in purchases by other consumers. Negative network externalities are just the opposite.

4 Chapter 4Slide 4 Network Externalities The Bandwagon Effect This is the desire to be in style, to have a good because almost everyone else has it, or to indulge in a fad. This is the major objective of marketing and advertising campaigns (e.g. toys, clothing).

5 Chapter 4Slide 5 Positive Network Externality: Bandwagon Effect Quantity (thousands per month) Price ($ per unit) D When consumers believe more people have purchased the product, the demand curve shifts further to the the right. D D D D 100

6 Chapter 4Slide 6 Demand Positive Network Externality: Bandwagon Effect Quantity (thousands per month) Price ($ per unit) D D 40 D 60 D 80 D 100 The market demand curve is found by joining the points on the individual demand curves. It is relatively more elastic.

7 Chapter 4Slide 7 Demand Positive Network Externality: Bandwagon Effect Quantity (thousands per month) Price ($ per unit) D D 40 D 60 D 80 D 100 Pure Price Effect 48 Suppose the price falls from $30 to $20. If there were no bandwagon effect, quantity demanded would only increase to 48,000 $20 $30

8 Chapter 4Slide 8 Demand Positive Network Externality: Bandwagon Effect Quantity (thousands per month) Price ($ per unit) D D 40 D 60 D 80 D 100 Pure Price Effect $20 48 Bandwagon Effect But as more people buy the good, it becomes stylish to own it and the quantity demanded increases further. $30

9 Chapter 4Slide 9 Network Externalities The Snob Effect If the network externality is negative, a snob effect exists. The snob effect refers to the desire to own exclusive or unique goods. The quantity demanded of a snob good is higher the fewer the people who own it.

10 Chapter 4Slide 10 Negative Network Externality: Snob Effect Quantity (thousands per month) Price ($ per unit) Demand 2 D2D2 $30,000 $15, Pure Price Effect Originally demand is D 2, when consumers think 2000 people have bought a good. 468 D4D4 D6D6 D8D8 However, if consumers think 4,000 people have bought the good, demand shifts from D 2 to D 6 and its snob value has been reduced.

11 Chapter 4Slide 11 Negative Network Externality: Snob Effect Quantity (thousands per month) 2468 The demand is less elastic and as a snob good its value is greatly reduced if more people own it. Sales decrease as a result. Examples: Rolex watches and long lines at the ski lift. Price ($ per unit) D2D2 $30,000 $15, D4D4 D6D6 D8D8 Demand Pure Price Effect Snob Effect Net Effect

12 Chapter 4Slide 12 Network Externalities and the Demands for Computers and Fax Machines Examples of Positive Feedback Externalities Mainframe computers: Microsoft Windows PC operating system Fax-machines and


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