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Indirect Network Effects and Adoption Externalities

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  • Church, Jeffrey
  • Gandal, Neil
  • Krause, David

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.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3738.

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Date of creation: Feb 2003
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Handle: RePEc:cpr:ceprdp:3738

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Keywords: network effects; network externalities;

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References

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  1. Joseph Farrell & Garth Saloner, 1986. "Installed Base and Compatibility, With Implications for Product Preannouncements," Working papers 411, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Church, Jeffrey & Gandal, Neil, 1993. "Complementary network externalities and technological adoption," International Journal of Industrial Organization, Elsevier, vol. 11(2), pages 239-260, June.
  3. Jeffrey Church & Neil Gandal, 1992. "Integration, Complementary Products, and Variety," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 1(4), pages 651-675, December.
  4. Nicholas Economides, 1997. "The Economics of Networks," Brazilian Electronic Journal of Economics, Department of Economics, Universidade Federal de Pernambuco, vol. 1(0), December.
  5. Spence, Michael, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 217-35, June.
  6. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  7. Economides, Nicholas, 1989. "Desirability of Compatibility in the Absence of Network Externalities," American Economic Review, American Economic Association, vol. 79(5), pages 1165-81, December.
  8. Church, Jeffrey & Gandal, Neil, 1992. "Network Effects, Software Provision, and Standardization," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 85-103, March.
  9. Chou, Chien-fu & Shy, Oz, 1990. "Network effects without network externalities," International Journal of Industrial Organization, Elsevier, vol. 8(2), pages 259-270, June.
  10. S. J. Liebowitz & Stephen E. Margolis, 1994. "Network Externality: An Uncommon Tragedy," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 133-150, Spring.
  11. Church, J. & Gandal, N., 1996. "Systems Competition, Vertical Merger and Foreclosure," Papers 6-96, Tel Aviv - the Sackler Institute of Economic Studies.
  12. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-41, August.
  13. Farrell, Joseph & Saloner, Garth, 1986. "Standardization and variety," Economics Letters, Elsevier, vol. 20(1), pages 71-74.
  14. Michael L. Katz & Carl Shapiro, 1994. "Systems Competition and Network Effects," Journal of Economic Perspectives, American Economic Association, vol. 8(2), pages 93-115, Spring.
  15. Carmen Matutes & Pierre Regibeau, 1988. ""Mix and Match": Product Compatibility without Network Externalities," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 221-234, Summer.
  16. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
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Citations

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Cited by:
  1. Simone Scholten & Ulrich Scholten, 2012. "Platform-based Innovation Management: Directing External Innovational Efforts in Platform Ecosystems," Journal of the Knowledge Economy, Springer, vol. 3(2), pages 164-184, June.
  2. Dachrahn Wu & Ming Chang & Mei-Hua Chang, 2008. "Market coverage and “love of software variety” in the supporting services approach," Netnomics, Springer, vol. 9(2), pages 77-86, October.
  3. Oz Shy, 2010. "A short survey of network economics," Working Papers 10-3, Federal Reserve Bank of Boston.
  4. Andrei Hagiu, 2004. "Two-Sided Platforms: Pricing and Social Efficiency," Discussion papers 04035, Research Institute of Economy, Trade and Industry (RIETI).
  5. Church, Jeffrey & Gandal, Neil, 2012. "Direct and Indirect Network Effects are Equivalent: A Comment on “Direct and Indirect Network Effects: Are They Equivalent?”," CEPR Discussion Papers 9097, C.E.P.R. Discussion Papers.
  6. María Fernanda Viecens, 2009. "Pricing strategies in two-sided platforms: The role of sellers’ competition," Working Papers 2009-11, FEDEA.
  7. Mª Mercedes Carmona Martínez & Leonarda García Jiménez, 2007. "Difusión del uso de Internet en España. ¿Existe una brecha digital entre Comunidades Autónomas?," Revista de Estudios Regionales, Universidades Públicas de Andalucía, vol. 3, pages 193-228.
  8. Pollock, R., 2009. "General Network Effects and Welfare," Cambridge Working Papers in Economics 0915, Faculty of Economics, University of Cambridge.
  9. Slivko, Olga, 2012. "Direct and indirect subsidies in markets with system goods in the presence of externalities. Preliminary version," Working Papers 2072/211631, Universitat Rovira i Virgili, Department of Economics.
  10. Kevin J. Boudreau & Andrei Hagiu, 2008. "Platform Rules: Multi-Sided Platforms as Regulators," Harvard Business School Working Papers 09-061, Harvard Business School.

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