Critical Mass and Network Evolution in Telecommunications


Nicholas Economides and Charles Himmelberg

Stern School of Business, New York University, New York, NY 10012-1126
(212) 998-0864 and (212) 998-0870, respectively. Fax: (212) 995-4812.
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December 1994


Network goods exhibit positive consumption externalities, commonly known as "network externalities." In markets, this fact can give rise to the existence of a critical mass point, that is, a minimum network size that can be sustained in equilibrium, given the cost and market structure of the industry. In this paper, we describe the conditions under which a critical mass point exists for a network good. We also characterize the existence of critical mass points under various market structures. Surprisingly, neither existence nor the size of the minimum feasible network depends on market structure. Thus, even though a monopolist enjoys an additional degree of freedom through its influence over expectations, and even though monopolistic and oligopolistic markets will in general provide a smaller sized network than perfect competition, the critical mass point is nonetheless the same. We extend these results by making the model dynamic and by generalizing it to allow durable goods. Introducing network externalities to a dynamic model of market growth increases the speed at which market demand grows in the presence of a downward time trend for industry marginal cost. We use this prediction to calibrate the model and obtain estimates of the parameter measuring a consumer's valuation of the installed base (i.e., the network effect) using aggregate time series data on prices and quantities in the US fax market.

Published in Toward a Competitive Telecommunications Industry: Selected Papers from the 1994 Telecommunications Policy Research Conference, Gerard Brock (ed.), 1995.

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