Compatibility and Market Structure for Network Goods

NYU Stern School of Business Discussion Paper No. 98-02

41 Pages Posted: 28 Apr 1998

See all articles by Nicholas Economides

Nicholas Economides

New York University - Leonard N. Stern School of Business - Department of Economics

Fredrick Flyer

Leonard N. Stern School of Business - Department of Economics

Date Written: November 1997

Abstract

This paper analyzes the economics of industries where network externalities are significant. In such industries, firms have strong incentives to adhere to common technical compatibility standards so that they reap the network externalities of the whole group. However, a firm also benefits from producing an incompatible product thereby increasing its horizontal product differentiation. We show how competition balances these opposing incentives. We find that market equilibria often exhibit extreme disparities in sales, output prices, and profits across firms, despite no inherent differences in the firms' production technologies. This may explain the frequent domination of network industries by one or two firms. We also find that the presence of network externalities dramatically affects conventional welfare analysis, as total surplus in markets where these externalities are strong is highest under monopoly and declines with entry of additional firms.

JEL Classification: L1, D4

Suggested Citation

Economides, Nicholas and Flyer, Fredrick, Compatibility and Market Structure for Network Goods (November 1997). NYU Stern School of Business Discussion Paper No. 98-02, Available at SSRN: https://ssrn.com/abstract=81268 or http://dx.doi.org/10.2139/ssrn.81268

Nicholas Economides (Contact Author)

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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HOME PAGE: http://www.stern.nyu.edu/networks/

Fredrick Flyer

Leonard N. Stern School of Business - Department of Economics ( email )

44 West Fourth Street, 7-180
New York, NY 10012
United States

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