Information Technology • Phones, Faxes, e-mail, etc. all have the following property: – Network externalities: The more people using it the more benefit it is to each user. • Computers, VCRs, PS 2 s, also have this property in that both software can be traded among users and the larger the user market, the larger number of software titles are made. • How do markets operate with such externalities?

Competition & Network Externalities • Individuals 1, …, 1000 (call this number v) • Each can buy one unit of a good providing a network externality. • Person v values a unit of the good at n*v, where n is the number of persons who buy the good.

Competition & Network Externalities • What is the demand at price p? • If v is the marginal buyer, valuing the good at nv = p, then all buyers v’ > v value the good more, and so buy it. • Quantity demanded is n = 1000 - v. • So inverse demand is p = n(1000 -n). • Graph this! • What is the supply curve if marginal cost c<250, 000?

Competition & Network Externalities • What are the market equilibria? • Zero. • A large numbers of buyers buy. – large n* large network externality value n*v – good is bought only by buyers with n*v c; i. e. only large v v* = c/n*. • The other point is unstable and called a threshold point. Below this, demand will go to zero. Above this, the product would be a hit.

Discussion points • Competitors: VHS vs. Beta, Qwerty vs. Dvorak, Windows vs. Mac, Playstation vs. Xbox, Blue-ray vs. HD-dvd. • Does the best always win? • Standardization helps with network externalities. – Drive on left side vs. right side. Out of 206 countries 144 (70%) are rhs. – Left is more nature for an army: swords in right hand, mounting horses. (Napolean liked the other way. ) – Sweden switched from left to right in 1967. • Lots of networks: Religions and Languages.

Homework. • Students like to go to the Haifa Ball depending upon how many other students go there. • Tickets cost 32 NIS each. • There are 1000 students indexed by i from 1 to 1000. • Student i has value vi=i. • Student i has utility (in shekels) for going to the Ball of vi⋅(n/(5000)), where n is the total number of students going to the Ball. • (i) If everyone believes n=500, which students will be willing to go to the ball? • (ii) What is the threshold number of tickets sold above which it will be a success and below which it will be a failure? • (iii) What is the equilibrium of tickets sold if the ball is a success? • (iv) What is the equilibrium of tickets sold if the ball is a failure?