Working Paper No. 03-13

Modeling Network Externalities, Network Effects, and Product Compatibility with Logit Demand
(Revision of Working Paper No. 03-06)
Collin Starkweather
November 2003

ABSTRACT

With the advent of the digital age, information goods characterized by strong positive network externalities and effects are playing an increasingly prominent economic role. A logit model of oligopolistic competition is presented with a focus on providing an accessible rigorous analytic framework for positive network externalities and effects.

In the presence of positive network externalities and effects, market behavior is quite different from that of traditional logit models. Multiple stable equilibria arise. Oligopoly producers respond to higher price elasticities with lower prices and markups. Markets tend to be highly concentrated and the dominant producer can remain dominant even while producing an inferior product. Strategic behaviors arise that do not exist in the absence of network externalities or effects.

JEL classification: C65; D11; D43; L13
Keywords: Discrete Choice; Network Externalities; Network Effects

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