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It is a well-documented fact that consumer choices are not only based upon their own preferences and income; they are also affected by the consumption choice of others. Spatial competition and retailing models have disregarded network influences on consumer behaviour by assuming that people always buy from the cheapest store. This also holds for product differentiation theory which has neglected to account for these phenomena. The literature on consumption externalities has neglected the fact that stores are not necessarily clustered and that consumers face transportation costs in addition to the consumption externality when choosing which brand to buy or which store to visit. In Discussion paper No 1306 Ami Navon, Oz Shy and Research Fellow Jacques Thisse explicitly integrate the location dimension into these environments, thus providing a general enough model to capture both positive and negative network externalities and to contrast stores' strategies under these two extreme models of consumer behaviourIn their paper they propose to add the consumption (or network) externality model to the location models to highlight the role of the network externalities in retailing and spatial competition. They then investigate the impact of stores' location on equilibrium prices, market shares, and welfare. They show when positive network externalities are present, price competition is fiercer and results in low equilibrium prices, yet both stores remain in business when transportation costs are not `too low'. When network externalities are strong enough, they dominate the transportation cost effect, resulting in a single store serving the entire market. Hence, the active store prices are below the monopoly price because of entry threats. When consumers' preferences exhibit negative network externalities, price competition is relaxed and firms have more market power. Hence, the market is characterized by higher equilibrium prices. This in turn may invite more stores to enter so that negative network externalities induce a larger variety of brands as often observed in luxury good industries. Product Differentiation in the Presence of
Positive and Negative Network Effects |