Indirect Network Effects and Adoption Externalities

Foerder Institute for Economic Research Working Paper No. 02-30

26 Pages Posted: 24 Mar 2003

See all articles by Jeffrey Church

Jeffrey Church

University of Calgary - Department of Economics

Neil Gandal

Berglas School of Economics, Tel Aviv University; Centre for Economic Policy Research (CEPR)

David Krause

Bell Canada; Carleton University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: December 19, 2002

Abstract

The conventional wisdom is that indirect network effects, unlike direct network effects, do not give rise to externalities. In this paper we show that under very general conditions, indirect network effects lead to adoption externalities. In particular we show that in markets where consumption benefits arise from hardware/software systems, adoption externalities will occur when there are (i) increasing returns to scale in the production of software, (ii) free-entry in software, and (iii) consumers have a preference for software variety. The private benefit of the marginal hardware purchaser is less than the social benefit since the marginal hardware purchaser does not internalize the welfare improving response of the software industry, particularly the increase in software variety, on inframarginal purchasers when the market for hardware expands.

Keywords: Network Externalities, Network Effects

JEL Classification: D62, L13

Suggested Citation

Church, Jeffrey and Gandal, Neil and Krause, David Peter, Indirect Network Effects and Adoption Externalities (December 19, 2002). Foerder Institute for Economic Research Working Paper No. 02-30. Available at SSRN: https://ssrn.com/abstract=369120 or http://dx.doi.org/10.2139/ssrn.369120

Jeffrey Church (Contact Author)

University of Calgary - Department of Economics ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

Neil Gandal

Berglas School of Economics, Tel Aviv University ( email )

Tel Aviv University
Tel Aviv 69978
Israel
+972 3 640 9907 (Phone)
+972 3 640 9908 (Fax)

HOME PAGE: http://www.neilgandal.com/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

David Peter Krause

Bell Canada ( email )

613-785-6344 (Phone)

Carleton University - Department of Economics ( email )

1125 Colonel By Drive
Ottawa, Ontario K1S 5B6
Canada

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