Topic 1: Network Ext and SC Flashcards
Network externalities and switching costs
band wagon effect
snowball effect
positive network externality
quanity of a good that one person demand increases based on the growth of purchases by other people
heterogenous network benefits
Heterogeneous network benefits refer to the advantages that arise when different types of users, devices, or services connect and interact within a network. These benefits come from the diversity of participants, as they enhance the network’s overall value by meeting varied needs and fostering new opportunities.
u(theta) = theta * n^e - p
heterogenous stand alone benefits
Heterogeneous stand-alone benefits refer to the individual advantages or value gained by diverse types of users, devices, or services from being part of a system or network, even if they function independently and do not interact directly with other parts of the system.
u(theta) = theta + n^e - p
what does theta denote
willingness to pay
Two types of consumer expectations are
myopic
fulfilled
myopic expectations
consumers base their expectations on the current network size
fulfilled expectation
consumers base their decisions on expectations on future size of the network (after all decisions are made) - assume that in equilibrium, these expectations are rational and turn out to be correct
size of the network (expected and actual) n^e
What is the demand function with network effects
p(n,n^e) = n^e(1-n)
theta - willingness therefore 1-theta will also subscribe
What are the three expectations equilibria
no consumer buys
small number of consumers buy - product purchased only by consumers with high valuation
large number of consumers buy - high expectation
Due to the presence of network effects that affect consumers’ utility
differently, there may exist multiple consumer equilibria for a given
price for the network good.
What criteria can be used to determine the best equilibrium among many
Stability - equilibrium should persist even id there is a small perturbation
pareto dominance: the preferred equilibrium should prevail
What is critical mass
unstable equilibrium (n1(p)) is called the critical mass..
Critcal mass is the Threshold number of consumers (or market share, or…) above which a
‘snowball effect’ starts, leading to the equilibrium with a large
network.
How are price and critical mass related
The critical mass is always a function of the market price, meaning
that a rise in price would imply an increase in the critical mass and
a decrease in the market price will decrease the critical mass
what are some strategies used to get to critical mass
penetration pricing (price < marginal cost)
Managing expectations (fers to the strategy of influencing consumer beliefs and perceptions about the future success of a product or network)
extending the existing network via strategic bundling
Discuss what are compatible and incompatible goods
Incompatible goods - exist with different networks, one good eventually dominates, competition for the market
compatible goods - single nextwork
several goods may coexist
competition in the market
can make goods compatible through standardization
Properties of competition between incompatible goods
Path dependence - outcome depends on the way in which adoptions build up
Inflexibility or lock in - left behind good will need to bridge a widening gap if it is chosen by adopters at all
Non-predictability - process locks into monopoly - but one cannot predict this before hand
Potential inefficiency -
Disucss relationship between demand for variery and high network effects
low demand for variety and high network effects (higher willingness to pay) == High likelihood of tipping
High demand for variety (less competition), less willingness to pay == low likelihood of tipping ;; otherwise it depends
Positive feedback
Weak get weaker, strong get stronger - winner takes the whole market
installed base
total number of products used
size of installed base of users can present a barrier to entry for new firms
collective switching costs
switching costs of all users
coordination problem
hard to convince users to switch to another technology even if it is superior -> nobody wants to be first -> this is worse that individual lock in
strong incentives for early movers to build a large installed base
competitors with significant product advantages or a better pricing strategy can overcome the advantage of an installed base
Ineffeciencies
Excess inertia - stick to old, inferior technology even though the new technology is superior
Excess momentum - consumers switch to a new technology,
even though the old technology is still more socially desirable
When there are network effects, the transition from an ‘old’ to a ‘new’
technology can be inefficient, due to a coordination problem between
users
How can a pareto dominating technology be coordinated with
if there is complete information and firms announce their choice of technology sequentially
if there is incomplete information, there is the possibility of excess inertia and excess momentum
How does switching costs affect price competition?
If consumers are already locked in using a specific product, firms may raise prices knowing that consumers will not not switch unless the price exceeds to cost to switch to the other brand
if consumers are not locked in, there will be intense competition
Describe lock in strategies
Offering complementary services and goods
automatic subscriptions
