Network Externalities and Long-Run Market Shares

Abstract

We study a dynamic duopoly model with differentiated products and network externalities. New consumers appear each period and the value of the product depends on the size of the network in the current and in the previous period, for example due to availability of add-ons or "software". Hence, the market outcome of a given period affects the future periods through its effect on installed base. When the products are of equal quality, we analyze whether or not the market chooses one product as a standard, in other words, if the market shares diverge. We compare the market outcome to a planner's problem and identify cases where the planner would choose one product as the standard but the market is unsuccessful in doing so. When products differ in quality, an inferior product may emerge with all of the market share even when the planner would choose the higher quality product, but only when the discount factor is sufficiently large.