Lecture 21 Final - EEP 143 Lecture 20 Networks Outline:...

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EEP 143 Lecture 20 Networks Outline: Introduction Direct Network Benefits Indirect Network Benefits
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Introduction Why a competitive market can fail 1. Public goods: 2 characteristics (remember?) Information goods (what solutions to market failure?) 2. Natural Monopoly Electricity distribution Phones? What solutions? 3. Monopolized markets Price fixing, collusion, predation What solutions? 4. Network effects
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Network externalities Physical networks (internet) Like natural monopoly Solution? Direct network externalities Indirect network externalities
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Introduction There are two types of network benefits: Direct: When users of the network care about the number of the users directly (e.g. multiplayer games online – the more the merrier) Indirect: When users know that if the network size increases, then the good’s quality is likely to be improved (does this work for Windows vs. OS for Macs?) A prevalent feature of markets that are characterized by networks is market tipping: Dominance is sequential and each firm becomes and stays a monopolist for only a short time period (Lotus vs. Microsoft Excel)
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Introduction “A network is a group of consumers who consume the same or a compatible good” (Scotchmer 2004) Consumers enjoy network benefits if their utility increases as the size of the network increases (i.e. as more people that consume the good increases) Examples? Text-editing software Computers Internet
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Introduction Networks usually involve standards examples before industrial revolution?
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Introduction Networks usually involve standards examples before industrial revolution? Standards can create a network
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Network standards: Examples before industrial revolution ? 1. Convention for mounting a horse- left side 2. Width of a Roman chariot Which in turn determined what? 3. Weights and measures – metric system 4. Traffic control 5. Language 6. Number system 7. Currency 8. Others? Can you relate these to Adam Smith? Which are bandwagon effects, which are “sponsored?”
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Network standards Institutions 1. Market-determined: Sponsored by firm or firms Flash memory VHS Unsponsored Bandwagon effects: Drive on which side of road? HTML?
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Network standards Institutions 2. De jure (determined by government) Metric system Spectrum allocation for broadcasting 3. Common voluntary agreement Languages, natural and otherwise? Others?
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Network effects In economic theory network benefits are known as: Positive Externalities A good has a positive externality if the private benefit of using it is higher than its social benefit: My enjoyment of my garden is not the only benefit this garden yields. Also my neighbors may enjoy seeing it (or not!!) Problems arise when the private benefit is not enough to cover the costs Even though the good is socially beneficial, the good will never be created unless there is a mechanism in place to motivate or compel production
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This note was uploaded on 08/01/2008 for the course ECON 143 taught by Professor Wright during the Fall '07 term at University of California, Berkeley.

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Lecture 21 Final - EEP 143 Lecture 20 Networks Outline:...

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