Network Externalities

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J. Hofmoki:

"The network effects concept was introduced to the economic literature in 1985 by M.L. Katz and C.Shapiro, who used the term ‘Network Externalities’. They noted that, in the case of many products, “the utility that a user derives from consumption of the good increases with the number of other agents consuming the good” (Katz, Shapiro, 1985:424). This concept was later refined by S. Liebowitz and S. Margolis, who argued that network effects, in their pure form, do not need to coincide with externalities; i.e. positive or negative effects on parties not involved in a given transaction (Liebowitz, Margolis, 1994). The added value of existing and new customers results from direct interactions between the users of a given good, as well as from the increased availability of complementary products and services.

Back in the 1980s and 1990s, when the network effects concept was introduced and refined, traditional telephone systems were viewed as the primary exemplification of these effects. Nowadays, with the rapid development of information technologies, the ICT sector is believed to demonstrate the most significant network effects, just to mention the development of the World Wide Web, where new essential functionalities were added once the number of Internet users increased. The same goes for websites facilitating exchanges via the Internet (eBay) or dedicated portals used for social networking. The developments taking place within the Internet spectrum clearly contrast with the classic CPR scenario. Specifically, the network effects increase radically once the number of users of a given Internet good reaches a certain threshold. For CPR goods, the increased number of users results in the excessive exploitation of a given resource.

While emphasizing the incidence and magnitude of positive network effects, particularly in the case of Internet Commons, I shall point out negative implications, as well. These are reflected in the so called ‘locked-in situations’, profoundly exemplified in the market for professional software applications, presently dominated by Microsoft. The providers of alternative applications, often of superior quality, have faced major obstacles convincing potential clients to shift from Microsoft Office. The clients were reluctant to lose obvious benefits derived from the network effects: compatibility with the applications used by their business partners, standard installations on purchased hardware, access to auxiliary services, additional combatable applications, etc. " (


Network Exernalities as Essential Aspects of P2P - Commons Economics

Robert Ryan:

"p2p is a solution to the fundamental problem of network externalities. We know this because the opposite of p2p is a system driven by centralized intermediaries that serve their own growth at the expense of all else around it.... thus, centralized intermediaries declare their own prices and quantities at rates unsustainable by all smaller, less influential nodes in the network....therefore, central intermediaries create radically different economic dynamics than a flatter network of nodes would create....central intermediaries create conflict with all adjacent social systems and/or consume all adjacent resources without regards to their true scarcity....centralized networks always underestimate scarcity of resources from the periphery, or threats from unsustainable competition, most especially because their network position itself creates an illusory mathematical quirk that supposes, in the short run, a surplus is infinitely scalable, and make peripheral nodes compete with each other to satisfy these nearly impossible prices forever ..... p2p networks burst this illusion by distributing power in greater accordance with the true scarcity (and interdependence) of resources.... largely because no node becomes large enough to override the natural interests of the rest of the nodes... early theories of georgist and environmental economics highlighted that flat networks who cannot externalize are the only ones correctly priced by an open market system.... naturally, according to George and Pigou, the best possible tax is a *land tax* aka network externalities tax that redistributes centralized power evenly through the network, which in turn eliminates externalities, therefore stabilizing the entire local landscape such that prices are consistent with true scarcity, fair, and sustainable ." (