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: Sony 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.

6. Aggregate Demand How do we get aggregate demand from individual demands? Two people with demands xA(p1,p2,m) and xB(p1,p2,m). Aggregate demand X=xA+xB. What does this look like with demand curves? Horizontal or Vertical addition?

7. Demand Review What is aggregate demand if –XA=10-p. –XB=20-p. What about if they only consume positive amounts of a good? –XA=Max{10-p,0}. –XB=Max{20-p,0}.

8. Which card should you use first? Seller has cards 3 and 5. The price is 6. Which should the seller use first? Should the seller save the best for last in order to increase sales? –Say the future price is pf=6. Profits are 4 no matter which card is used first. –Say pf=4 and the seller uses 5 first. The seller can then use the 3 card and make profits 6-5+4-3=2. –Say pf=4 and the seller uses 3 first. The seller cannot sell the new unit and will make profits of 6-3=3. Selling less may be better! Always use the lowest card first. (Or highest card first for buyers).

9. Does tax incidence matter? Public thinks so, economics thinks not. –US taxes cigarettes while subsidizing tobacco farmers. –In Canada replacing a manufacturer’s tax with a consumer tax cause a PM to resign. Equilibrium is for sellers’ tax S(p1-t)=D(p1) or for buyers’ tax S(p2)=D(p2+t). If p2=p1-t, it is the same. Cost is the same. Net of taxes: Sellers get p1-t. Buyers pay p1. Government gets t*D(p1).