Application 10.4 Hoe Do Network Externalities Effect Supply Curves?
Network externalities arise when aging additional users a network cause cost to decline. Such externalities are common in many modern industries in telecommunication and Internet technology. Their presence sets the stage for declining prices as demand expands.
Metcalfe’s Law
A basic property of communications networks is that they obey Metcalfe’s Law, a principle named for Robert Metcalf, a pioneer in the development of Ethernet technology. The law states that the usefulness of given network varies directly with the aquare of the number of subscribers to that network.1 This implies that the value of such a network expands much more rapidly than do the costs associated with establishing it. Such increasing returns combined with the impact of rapid change in communications technology itself have led to strong downtrends in the prices of many types of communications networks.
Some Examples
Examples of network externalities occur in the telecommunications, software, and Internet industries: