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Indirect Network Effects and Adoption Externalities

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  • Gandal, Neil
  • Church, Jeffrey
  • Krause, David

Abstract

The conventional wisdom is that indirect network effects, unlike direct network effects, do not give rise to externalities. In this Paper we show that under very general conditions, indirect network effects lead to adoption externalities. In particular we show that in markets where consumption benefits arise from hardware/software systems, adoption externalities will occur when there are (i) increasing returns to scale in the production of software, (ii) free-entry in software, and (iii) consumers have a preference for software variety. The private benefit of the marginal hardware purchaser is less than the social benefit since the marginal hardware purchaser does not internalize the welfare improving response of the software industry, particularly the increase in software variety, on inframarginal purchasers when the market for hardware expands.

Suggested Citation

  • Gandal, Neil & Church, Jeffrey & Krause, David, 2003. "Indirect Network Effects and Adoption Externalities," CEPR Discussion Papers 3738, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3738
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    References listed on IDEAS

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    More about this item

    Keywords

    Network externalities; Network effects;

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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