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Identification of Network Externalities in Markets for Non-Durables

  • Michal Grajek

This paper introduces a structural econometric model of consumer demand for non-durable goods, which exhibits network externalities. The structural model allows us to identify the parameters, which determine the strength of the externalities in the underlying economic model from the empirical estimation results. The estimates of these parameters can then be employed to test the economic significance of the externalities and the compatibility of networks. The identifying assumption that drives our results is that consumers care about the lagged instead of the current network size. We argue that it does not necessarily bound their rationality. To complete our structural model, we provide an example of functional specification that yields a simple linear stochastic model of demand. Using this functional specification, we identify all structural parameters of the model. In the end, the estimation and the stochastic structure of the resulting econometric model are discussed. ZUSAMMENFASSUNG - ( Identifikation der Netzwerkeffekten in den Märkten für nicht-dauerhafte Güter) Der vorliegende Beitrag stellt ein strukturelles ökonometrisches Modell der Konsumnachfrage für nicht-dauerhafte Güter mit externen Netzwerkeffekten vor. Das strukturelle Modell lässt uns die Parameter von Netzwerkeffekten im zugrunde liegenden ökonomischen Modell empirisch zu identifizieren. Die Schätzer der Strukturparameter könnten für das Testen der Netzwerkkompatibilität und der ökonomischen Signifikanz der Netzwerkeffekte verwendet werden. Für die Identifikation nehmen wir an, dass die Konsumenten die Netzwerksgröße verzögert wahrnehmen. Wir argumentieren, dass diese Annahme nicht notwendigerweise mit irrationalem Verhalten gleichzusetzen ist. Um das strukturelle Modell zu vollständigen, geben wir eine funktionale Spezifikation, aus der ein lineares stochastisches Nachfragemodell folgt. Unter Verwendung dieser Spezifikation sind alle Strukturparameter von dem Modell identifiziert. Zum Schluss diskutieren wir die Schätzung und die stochastische Struktur des sich ergebenden ökonometrischen Modells.

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Paper provided by Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG) in its series CIG Working Papers with number FS IV 02-32.

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Length: 37 pages
Date of creation: Dec 2002
Date of revision:
Handle: RePEc:wzb:wzebiv:fsiv02-32
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  1. Erik Brynjolfsson & Chris F. Kemerer, 1993. "Network Externalities in Microcomputer Software: An Econometric Analysis of the Spreadsheet Market," Working Paper Series 158, MIT Center for Coordination Science.
  2. 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.
  3. Gandal, N. & Greenstein, S. & Salant, D., 1995. "Adoptions and Orphans in the Early Microcumputer Market," Papers 02-95, Tel Aviv.
  4. Farrell, Joseph & Shapiro, Carl, 1988. "Dynamic Competition with Switching Costs," Department of Economics, Working Paper Series qt1h02g9q4, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Farrell, Joseph & Klemperer, Paul, 2007. "Coordination and Lock-In: Competition with Switching Costs and Network Effects," Handbook of Industrial Organization, Elsevier.
  6. Klemperer, Paul, 1992. "Competition When Consumers Have Switching Costs: An Overview," CEPR Discussion Papers 704, C.E.P.R. Discussion Papers.
  7. Jain, Dipak C & Rao, Ram C, 1990. "Effect of Price on the Demand for Durables: Modeling, Estimation, and Findings," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 163-70, April.
  8. David Dranove and Neil Gandal., 2000. "The DVD vs. DIVX Standard War: Empirical Evidence of Vaporware," Economics Working Papers E00-293, University of California at Berkeley.
  9. Nicholas Economides, 1997. "The Economics of Networks," Brazilian Electronic Journal of Economics, Department of Economics, Universidade Federal de Pernambuco, vol. 1(0), December.
  10. Marc Rysman, 2004. "Competition Between Networks: A�Study of the Market for Yellow�Pages," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 483-512, 04.
  11. Economides, Nicholas & White, Lawrence J., 1994. "Networks and compatibility: Implications for antitrust," European Economic Review, Elsevier, vol. 38(3-4), pages 651-662, April.
  12. Gandal, Neil, 1995. "Competing Compatibility Standards and Network Externalities in the PC Software Market," The Review of Economics and Statistics, MIT Press, vol. 77(4), pages 599-608, November.
  13. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
  14. Dan Horsky, 1990. "A Diffusion Model Incorporating Product Benefits, Price, Income and Information," Marketing Science, INFORMS, vol. 9(4), pages 342-365.
  15. Blonski, Matthias, 2002. "Network externalities and two-part tariffs in telecommunication markets," Information Economics and Policy, Elsevier, vol. 14(1), pages 95-109, March.
  16. 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.
  17. Cabral, Luis M. B., 1990. "On the adoption of innovations with 'network' externalities," Mathematical Social Sciences, Elsevier, vol. 19(3), pages 299-308, June.
  18. 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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