Question

Define network externalities.

What are the main characteristics that distinguish network industries from other industries.

Briefly, illustrate these characteristics.

Answer 1

Network externalities refers to a situation where the consumption and demand of a product is interdependent with some other persons.the consumption and demand increases and decreases with respect to other persons consumption.

Main characteristics -the network externalities can be elaborated and classified in two terms-

1. positive network externality(bandwagon effect)
2. negative network externality(Snob effect)

positive network externality(bandwagon effect)-

1. positive network externality implies that when a person consume any good and service and people get encourage to consume the same thing.therefore the demand of the goods and services increases whether the seller decrease or may not decrease the price.but in other industry,generally ,the demand of the product can be increased when a seller decreases the price.
2. positive network externality is also known as bandwagon effect,it can be illustrated as below-
3. suppose A has purchased a computer for sending Email to his friend B.therefore A purchased computer and availed the internet facility.B will also has to buy computer and avail internet service to receive email.the neighbor B also got encouraged and he too purchased the computer and availed the internet service.in the above example we can see by the demonstration effect the people are increasing there consumption by seeing each other and firm is experiencing the maximum profit and able to sell additional unit of commodity and services without declining the price which is a major difference compare to the ordinary firm demand concept.

negative network externality(Snob effect)-

• sometimes when demand of a particular/unique thing increases then it would lead to decrease the value of goods to posses them.therefore this creates a negative externalities.
• the firm has not increased the price of the product but still the demand of the cars have been declined due to increase in the level of business which is a also another major difference compare to the ordinary firm demand concept.this is known as SNOB EFFECT
• illustration-suppose the demand for luxurious car has increased and therefore, people who were ready to buy the product due to the uniqueness and considered as a status symbol won't buy it anymore, because earlier only a few person were able to buy it and therefore the car possessed greater value but now it can be purchased by anyone therefore there would be a bend in the demand curve.