DP1306 Product Differentiation in the Presence of Positive and Negative Network Effects

Author(s): Ami Navon, Oz Shy, Jacques-François Thisse
Publication Date: December 1995
Keyword(s): Location, Network Effects, Network Externalities, Product Differentiation
JEL(s): L1, R3
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1306

Using two standard location models, we investigate price competition and divergence from optimal product differentiation when consumer preferences are influenced by the number of consumers purchasing the same brand or shopping at the same store. Negative network effects tend to lessen competition and increase prices whereas positive network effects (bandwagon effects) make competition fiercer and lead to lower prices. Furthermore, in the duopoly case, an increase in total population may adversly affect the clients of a store despite the fact that they benefit from price cuts. Finally, under free entry, increasing the population may lead to a reduction in the equilibrium number of stores and always increases the divergence between the equilibrium and optimal numbers of stores.