Betting on the Trend: An Experimental Study on Network Externalities With Continuous Demand

40 Pages Posted: 28 Nov 2006

See all articles by Vincent Mak

Vincent Mak

University of Cambridge - Cambridge Judge Business School

Rami Zwick

University of California, Riverside

Date Written: October 18, 2006

Abstract

We study consumer decision making in a market with network externalities, in which the utility of a purchase increases with the number of purchasers. While research in this area typically models the consumer as making a binary choice, we propose a new model with continuous individual demand, thus allowing for sensitive gauging of agents' belief towards the product's success. We derive a payoff function that can be implemented experimentally as a voluntary contribution game with non-standard characteristics including: (1) Free-riding is impossible; (2) Contribution is profitable iff total contribution exceeds a critical mass; (3) There are two pure-strategy Nash equilibria, one incurring zero contribution, while the other has full-endowment contribution from all players to achieve Pareto optimality. We collect experimental data for the repeated game, which show that the Pareto-optimal equilibrium is not reached under some conditions. We propose a behavioral theory to interpret the data and conclude that: (1) Behavior is influenced by social and game-theoretic factors; (2) Convergence to the Pareto-optimal equilibrium is more likely than not when the critical mass is less than approximately half of the population's total endowment; (3) The difference between first-round total contribution and the critical mass predicts convergence type and efficiency.

Keywords: Network externalities, critical mass, consumer behavior, decision-making, coordination, learning in games, voluntary contribution game, game theory, experimental economics

JEL Classification: C72, C92, D62

Suggested Citation

Mak, Vincent and Zwick, Rami, Betting on the Trend: An Experimental Study on Network Externalities With Continuous Demand (October 18, 2006). HKUST Business School Research Paper No. 07-01, Available at SSRN: https://ssrn.com/abstract=947688 or http://dx.doi.org/10.2139/ssrn.947688

Vincent Mak

University of Cambridge - Cambridge Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom
+44 (0)1223 764295 (Phone)
+44 (0)1223 339701 (Fax)

Rami Zwick (Contact Author)

University of California, Riverside ( email )

900 University Avenue
Riverside, CA 92521
United States

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