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5.4 MARKET DEMAND 185

APPLICA TION 5.6
Externalities in Social Networking founded in 2002. By the end of 2003 it had 83,000
users. Two years later it had 4 million users, and by
Websites mid-2009 it had 43 million users.
Facebook has seen an even more dramatic rise.
Many products exhibit positive network externalities. Founded in 2004, the site had over 300 million users
An obvious example is telephones. A consumer would worldwide by late 2009, and it was available in over 50
find little value in having a telephone unless there were languages. Facebook is popular with a wider popula-
other people with telephones. For most people, a tele- tion than LinkedIn, as its design is more flexible and
phone becomes more useful as the number of other encourages different types of users to use the site in
people with telephones increases. To some extent, a different ways. For example, alumni from a specific
software application like Microsoft Word provides high school and year can locate each other, become
another example. Consumers value using the most pop- Facebook “Friends,” and set up a group to post infor-
ular document formats, since doing so makes it easier to mation related to their school. A member can set up or
share created documents with others. Instant messag- join many groups simultaneously, with different pur-
ing services offer a further example. As a specific mes- poses. Many Facebook users treat the site as a blog,
saging service becomes more popular, it also creates posting information about their current activities, in-
more value to a given consumer because the service can terests, or links to articles on the Internet related to a
be used to communicate with more people. particular theme. This flexibility has enabled Facebook
In recent years we have witnessed a dramatic to grow extremely rapidly in popularity.
increase in social networking sites such as Facebook, Such explosive growth is quite common in goods
LinkedIn, and Twitter. Consider the experience of with positive network externalities because band-
LinkedIn, a site that allows businesspeople to post wagon effects often get stronger as a particular
information about their credentials and career expe- product becomes more popular. A positive network
rience. Many professionals use LinkedIn to search for externality can make it very difficult for a new en-
jobs, develop contacts within their industry, or find trant in the market, even when a new rival offers ad-
new customers for their services. LinkedIn was vantages in quality, availability, or price.

Finally, positive network externalities can occur if a good or service is a fad. We
often see fads for goods and services that affect lifestyles, such as fashions of clothing,
children’s toys, or beer. Advertisers and marketers often try to highlight the popularity
of a product as part of its image.
Figure 5.22 illustrates the effects of a positive network externality. The graph
shows a set of market demand curves for connections to the Internet. For this example,
let’s assume that a connection to the Internet refers to a subscription to a provider of
access to the Internet, such as America Online or Microsoft Network. The curve D 30
represents the demand if consumers believe that 30 million subscribers have access to
the Internet. The curve D represents the demand if consumers believe that 60 million
60
subscribers have access. Suppose that access initially costs $20 per month and that
there are 30 million subscribers (point A in the graph).
What happens if the monthly price of access drops to $10? If there were no posi-
tive network externality, the quantity demanded would simply change to some other
point on D . In this case, the quantity of subscriptions would grow to 38 million (point
30
B in the graph). However, there is a positive network externality; as more people use
e-mail, instant messaging, and other Internet features, even more people want to sign up.
Therefore, at the lower price, the number of consumers wanting access will be even
greater than a movement along D 30 to point B would indicate. The total number of
subscriptions actually demanded at a price of $10 per month will grow to 60 million