What are Network Effects?
Network externalities may be positive or negative. In our analysis of demand we have assumed that demand for goods of different individuals are independent of one and another.
That is, demand for Pepsi by Amit depends on his own tastes, his income, price of Pepsi etc.
The assumption of independence of demands of different individuals enabled us to derive a market demand curve for a good by simply summing up horizontally the demands of different individuals consuming a good. In such cases of interdependence of demands of different individuals economists say network externalities are present.
People Network externalities telephone connection so that they can communicate with each other. If no one else has a telephone connection, it is certainly not useful for you to demand a telephone connection.
The same applies to demand for fax machines, mobile phones, modems, internet connection etc.
Internet connection is very useful to you if there are some other individuals or institutions have internet facilities with whom you can communicate. Network externalities can arise Network externalities a fashion or stylishness.
The desire or demand for wearing jeans by girls is influenced by the number of other girls who have chosen to wear them. Wearing jeans have become a fashion among the college going girls at metropolitan cities in India. To be in keeping with the fashion, more and more girls have opted for wearing jeans.
This has led to the increase in demand for jeans. However, it may be noted that network effects here go two ways. It is better if there are some others who have adopted the fashion, but if too many people go in for this, the fashion falls out of style and this adversely affects the demand for the good by others.
Another type of network externalities arises in case of complementary goods. The intrinsic value of a good is greater if its complementary good is available.
Thus, it is not worthwhile to open a CD discs store in a locality if only one person in the area has a CD player.
If the number of people owning CD players increases significantly, desire for opening CD discs store or for manufacturing CD discs will increase. Thus, the more the number of individuals who own CD players, the more CD discs will be produced.
In this case the demand for CD players depends on the number of CD discs available and the demand for CD discs depends on the number of people having CD players. Thus this is a more general form of positive network externalities.
The existence of positive network externalities gives rise to Bandwagon effect. Bandwagon effect refers to the desire or demand for a good by a person who wants to be in style because possession of a good is in fashion and therefore many others have it.
It may be noted that this bandwagon effect is the important objective of marketing and advertising strategies of several manufacturing companies who appeal to go in for a good as people of style are buying it.
Let us explain how to derive a demand curve for a good incorporating the bandwagon effect. This is illustrated in Figure 6. Suppose consumers think that only 10 thousand people in Delhi have purchased the good. This is a relatively small number of people compared to the total population of Delhi.
So the other people have little incentive to buy the good to satisfy their instinct of living in style. However, some people may still purchase because it has a intrinsic value for them. In this case the demand for the good is given by the demand curve D Now suppose that they think that 20 thousand people have purchased the good.Pecuniary externalities do not impose deadweight losses if left uninternalized, whereas they do impose (monopoly or monopsony) losses if internalized.
An interesting aspect of the network externalities literature is that it seemed to ignore, and thus repeat, earlier mistakes regarding pecuniary externalities. network externalities - when person’s demand depends on someone else’s demands.
positive network externality - to be in style, be like everyone else (bandwagon effect) marketing to make good popular (not banking on low costs, good quality). Network externalities are a special kind of externalities in which one individual’s utility for a good depends on the number of other people who consume the commodity.
For example, a consumer’s demand for ‘telephone’ depends on the number of other people owning the telephone connections. Indirect network externalities thus appear to be either pecuniary externalities, which require no remediation, or the reflection of conventional market failures in upstream markets.
Introduction of the concept of indirect network externalities takes something that has long been recognized and (to some degree) understood and presents it as something new and unfamiliar. Positive network externalities exist if the benefits (or, more technically, marginal utility) are an increasing function of the number of other users.
Negative network externalities exist if the benefits are a decreasing function of the number of other users. Network externalities are the effects on a user of a product or service of others using the same or compatible products or services. Positive network externalities exist if the benefits (or, more technically, marginal utility) are an increasing function of the number of other users.