Two-Firm Scenario

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Analysis of the Two-Firm Equilibria

This topic demonstrates some of the equilibria possible in the case of two firms facing network externalities. It's interesting to compare the firms' outputs in the different scenarios.

In particular, recall the two symmetric (i.e. equal-output) equilibria. The output of each firm is 13.74 when the firms are compatible with each other, 10.37 when they are incompatible. Clearly, each firm profits by being compatible with the other. This is a direct result of the network externalities assumption: when the firms are joined together in a network, the value of their products to consumers increases, so they attract more consumers and increase their production.

Note, also, that 18.15, the output of a single monopolist, is higher than 13.74, the output of each firm in the full compatibility equilibrium. In other words, if one firm controls the entire market, and a small firm introduces a rival, compatible product, then the monopolist loses profit from the transaction, while the small firm gains from it.

In the next topic, we are going to explore and characterize some of the equilibria that result in the three-firm case.

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