Question

Consider the market for a single network good and suppose that consumers differ in their

valuation of both the stand-alone and the network benefits (it can indeed be argued that

it is more plausible that a user who has a higher value for the stand-alone component

of a technology also assigns more importance to the size of its network.) To capture this

idea, write the consumers’ utility function for joining the network as U(θ) = θ(a + νne),

where a is the stand-alone benefit, ν > 0 measures the network effect, ne is the expected

number of users joining the network, and θ is uniformly distributed on the unit interval

(i.e. between zero and one).

a) Identify the indifferent consumer for a given price p and a given expected network

size ne.

b) Express the willingness to pay for the nth unit of the good when ne units are

expected to be sold.

Answer 1

a) Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. The Network Effect is a phenomenon where present users of a product or service benefit in some way when the product or service is adopted by additional users.

b) Willingness to pay is the maximum price a customer is willing to pay for a product or service.