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# ch24 - Network Issues Chapter 24 Network Issues 1...

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Chapter 24: Network Issues 1 Network Issues

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Chapter 24: Network Issues 2 Introduction Some products are popular with individual consumers precisely because each consumer places a value on others using the same good A telephone is only valuable if others have one, too Each user of Microsoft Windows benefits from having lots of other Windows users Users can run applications such as Word on each other’s computers More applications are written for operating systems with many users Network Effects or network externalities reflect such situations in which each consumer’s willingness to pay for a product rises as more consumers buy it Strategic interaction in a market with network effects is complicated
Chapter 24: Network Issues 3 Monopoly Provision of a Network Service An early model by Rohlfs (1974) illustrates many of the issues that surround markets with network effects Imagine some service, say a cable network, where consumers “hook” up to the system but the cost of providing them service after that is effectively zero The provider is a monopolist and charges a “hook up” fee but no other payment The basic valuation of the product v i is uniformly distributed across consumers from 0 to \$100. Consumer willingness to pay is fv i where f is the fraction of the consumer population that is served The i th’s consumer’s demand is: q i D = 0 if fv i < p 1 if fv i p

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Chapter 24: Network Issues 4 Monopoly Provision of a Network (cont.) Consider the marginal consumer with basic valuation pf v = ~ The firm will serve all consumers with valuations greater than v ~ Solving for the fraction f of the market served we have: f = 1 - 100 / ~ v = 1 – p/100 f So, the inverse demand function is: p = 100 f (1 – f )
Chapter 24: Network Issues 5 Monopoly Provision of a Network (cont.) The inverse demand curve has both upward and downward sloping parts. This means that there are two possible values for the fraction of the market served at any price p. \$/unit = p 0 0.2 0.4 0.6 0.8 1 f 25 20 15 10 5 0 \$22.22 f L f H

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Chapter 24: Network Issues 6 Monopoly Provision of a Network (cont.) The Rohlfs model makes clear many of the potential problems that can arise in markets with network effects 1. The market may fail altogether Suppose the firm must set a fee over \$30 perhaps to cover fixed costs
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