Network Externalities

Instead of using Marginal private benefit and marginal social benefit to analyse, we can use think of some occasions where MPB is proportional to number of users consuming the same product, or MPC being proportional to the number of users consuming that product.

One example is traffic congestion. Instead of using the model where MSC is greater than MPC, we can use the observation that the MPC of using the roads is proportional to the number of car users already on the road. And the observation that MPB for using the road is alot higher than other alternatives around. Then, it is not as simple as the driver being ignorant of the external costs that he is bringing to other drivers by merely being on the road. After all, we all do not like to be caught in a traffic jam. In this case, there is market failure, because firstly, there is incomplete information of car users. Secondly, most car users assume that the chances that other car users will all simultaneuously hit the roads is rather low. Thirdly, different people have different proportionality constants for the calculation of MPC. Some people might feel that he is not so much in a hurry, and so can tolerate the presence of more cars on the road.

In S'pore, the incomplete information bit is solved through sign boards that announce to car users way beforehand where there is traffic congestion. Also, car users are encouraged to call in to the radio stations to report where traffic congestions are forming. Next, possibly, we need inform users where and when the car traffic is likely to get worse. Possibly during peak hours. Of course we have other measures in place to reduce the relative MPB of using car vs. travelling by other means, for each of us. ERP, COE, possibly private bus companies that provide luxury rides, or cheaper public transport fares.

Hence, we can see network externalities arises whenever you have MPC/MPB that is proportional the number of other people around you, and not just rigidly determined by yourself. Network externalities arise in cases such as the success of Microsoft, healthcare, etc. The important implication about network externalities is that the starting point matters. If you start in a state where nobody is using the product initially, and the MPB is proportional to no. of people already using it, then you find that nobody will ever start to use the product.

Network externalities can also possibly explain why there is little class participation, why a group of people can suddenly 'stone' in the middle of nowhere..