Strength of the Network Externality

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Weakening the Network Externality Function to Destabilize a Monopoly

Note: in order to run the simulation referred to in this slide, go here, to the Java Applet version. You will be directed to download the latest version of the Java plug-in.

On this slide, we have set up a scenario with three incompatible firms that start off in a monopolistic equilibrium. If you press "Go" several times, the value of β will be decreased steadily, thus decreasing the network externality effect. As we expect, the output of the monopolist decreases, since the value of her good to consumers goes down. This can be readily seen on the graph below.

The most interesting feature occurs when the value of β crosses beneath 3.87. Below this value, a monopoly can no longer be supported. The network externality effect is so weak that it becomes profitable for another firm to start producing output. Thus, the simulation settles quickly into the next possible equilibrium - a duopoly.

If you continue to press "Go," β decreases even further As we know from the previous slide, when β crosses 2.74, a symmetric two-firm equilibrium can no longer be supported, and all three firms attain equal output.

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