Network Externalities and the Path Dependence of Markets: Will Bill Gates Make It?

Max Keilbach

No 711, Computing in Economics and Finance 1999 from Society for Computational Economics

Abstract: The evolution of markets in which network externalities prevail can be expected to differ from "classical markets," where no such externalities exist. We argue (with others) that network externalities lead to path-dependent behaviour in a market. Then, we suggest a formal model that is general enough to describe the dynamics of markets both with and without path-dependence. The approach is based on a flexible demand function, which models demand elasticity with respect to price and market share of the technology under consideration. This approach allows us to identify whether a market is path-dependent or not. Next we simulate different market scenarios using generalized (i.e., nonlinear) Polya-urns, where we consider different types of firm price setting behaviour. We show that, even under network externalities, several technologies can coexist; that is, the market need not move towards a lock-in state where only one technology "survives". But even if no network externalities prevail, it is possible for only one technology to stay in the market. The paper concludes with an empirical test of the model in which we consider the market of UNIX-workstations. Results give evidence for path dependence in this market. From the data, we identify a stable equilibrium for the market share of SUN-workstations at 35%. Of course, this is a tentative result, based on the assumption of constant price-setting behaviour (but not constant prices) by SUN microsystems. Nevertheless, the result well illustrates the behaviour of the model. Although we did not analyze the market for PC's empirically (since we could not obtain the relevant data at a reasonable price) the results of the simulations indicate that it is not only price policy or market share that determines the outcome in a path-dependent market like the one for PC operating systems or web-browsers. Other factors, like technology or contract pressures, play important roles.

Date: 1999-03-01
New Economics Papers: this item is included in nep-ind
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