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The Welfare Effect of Quality Degradation in the Presence of Network Externalities

  • Jong-Hee Hahn


    (Department of Economics, Keele University, Keele,)

This paper examines how the presence of network externalities affects a monopolist’s incentive for quality degradation and its welfare consequence. The software and the Internet service industries provide our primary motivation. The network externality may lead to a Pareto-improving quality degradation that would not be realised in the absence of network externalities. However, it may also overturn a potentially Paretoimproving quality degradation to a welfare-reducing one, or result in the realisation of a welfare-reducing quality degradation that would be avoided without network externalities. We also endogenise the firm’s forward and backward compatibility decisions between the original good and the degraded good. Key Words : Damaged Goods, Quality Degradation, Network Externalities, Compatibility,Price Discrimination, Software

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Paper provided by Department of Economics, Keele University in its series Keele Department of Economics Discussion Papers (1995-2001) with number 2001/08.

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Length: 24 pages
Date of creation: 2001
Date of revision: Feb 2003
Publication status: Published in Information Economics and Policy, 2004, vol. 16, issue 4, pages 535-552. [ doi:10.1016/j.infoecopol.2003.07.002 ]
Handle: RePEc:kee:keeldp:2001/08
Contact details of provider: Postal: Department of Economics, University of Keele, Keele, Staffordshire, ST5 5BG - United Kingdom
Phone: +44 (0)1782 584581
Fax: +44 (0)1782 717577
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Order Information: Postal: Department of Economics, Keele University, Keele, Staffordshire ST5 5BG - United Kingdom
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  1. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
  2. Nicholas Economides, 1997. "The Economics of Networks," Brazilian Electronic Journal of Economics, Department of Economics, Universidade Federal de Pernambuco, vol. 1(0), December.
  3. Bensaid, Bernard & Lesne, Jean-Philippe, 1996. "Dynamic monopoly pricing with network externalities," International Journal of Industrial Organization, Elsevier, vol. 14(6), pages 837-855, October.
  4. Raymond J. Deneckere & R. Preston McAfee, 1996. "Damaged Goods," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 5(2), pages 149-174, 06.
  5. Choi, Jay Pil, 1994. "Network Externality, Compatibility Choice, and Planned Obsolescence," Journal of Industrial Economics, Wiley Blackwell, vol. 42(2), pages 167-82, June.
  6. Luis Cabral & David Salant & Glenn Woroch, 1994. "Monopoly Pricing With Network Externalities," Industrial Organization 9411003, EconWPA.
  7. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  8. Michael Waldman, 1993. "A New Perspective on Planned Obsolescence," The Quarterly Journal of Economics, Oxford University Press, vol. 108(1), pages 273-283.
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