The Economics of Networks: Network Externalities and Industry Structure The Economics of Networks

4. Network Externalities and Industry Structure

4.1 Invitations to Enter

In the presence of strong network externalities, a monopolist exclusive holder of a technology may have an incentive to invite competitors and even subsidize them. The realization of network externalities requires high output. A monopolist may be unable credibly to commit to a high output as long as he is operating by himself. However, if he licenses the technology to a number of firms and invites them to enter and compete with him, market output will be higher; and since the level of market output depends mainly upon other firms, the commitment to high output is credible.

The invitation to enter and the consequent increase in market output has two effects; a competitive effect and anetwork effect. The competitive effect is an expected increase in competition because of the increase of the number of firms. The network effect tends to increase the willingness to pay and the market price because of the high expected sales. Economides (1993b), (1996a) shows that, if the network externality is strong enough, the network effect is larger than the competitive effect, and therefore an innovator-monopolist invites competitors and even subsidizes them on the margin to induce them to increase production.

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