Market Failures, Externalities, Asymmetries & Bandwagon ...

Market Failures, Externalities, Asymmetries & Bandwagon Effects
Yale BraunsteinMarch 2011
Quick intro to “Consumers Surplus”
Actually, the sum of CS & PSConsumers gain from price decreasesPS = ProfitMonopoly works by restricting output & raining price, therefore results in “deadweight welfare loss”Graphical measure of DWL
Market Failure
Need a formal definitionMore than just “market doesn’t do what we want it to do”Role of monopolizationRole of information asymmetries(Price discrimination can actually be beneficial)But this is not always the case
Externalities
Can be positive or negativeCan occur from production or consumption2x2 diagram of examples
“Solutions” to externalities
TaxesSubsidiesRegulationBetter definition of property rights“Unitization” as an exampleMore when we get toCoases’ Theorem
Bandwagon effects - History
HarveyLeibenstein,1950H.Leibenstein, “Bandwagon, Snob, and Veblen Effects in the Theory of Consumers’ Demand,”The Quarterly Journal of Economics (May 1950), reprinted in W.Breitand H.M.Hochman, Readings in Microeconomics, Second Edition (New York: Holt, Rinehart and Winston, Inc., 1971), pp. 115-116“the extent to which the demand for a commodity is increased due to the fact that others are also consuming the same commodity. It represents the desire of people to purchase a commodity in order to get into ‘the swim of things’; in order to conform with the people they wish to be associated with; in order to be fashionable or stylish; or, in order to appear to be ‘one of the boys.’”
History (2)
Jeffrey H.Rohlfs,1974J.Rohlfs, “A Theory of Interdependent Demand for a Communications Service,”Bell Journal of Economics and Management Science (Spring 1974),p. 16.“The utility that a subscriber derives from a communications service increases as others join the system. This is a classic case of external economies in consumption and has fundamental importance for the economic analysis of the communications industry.”
Network Externalities with an example from the 1980s – The Fax
Bandwagoneffects in high tech industries often have a basis that goes beyond what is in the consumer’s head. In particular:Networkexternalities: Thebenefit from being able to communicate with additional individuals who have also become users of the product or service (these apply to products and services that use telecommunications networks.)(Example: the fax machine) Externaldemand-side scale economics: Benefitsthat accrue to consumers as the user set expands. They areexternal to a single user, because the benefits to him or her derive from actions of others.
Metcalfe’s Law
Valueof network to users increases exponentially with the number of nodes/users(Don’t believe everything you read inWikipedia. Not necessarily a “square” law, and it didn’t come from George Gilder.)(Role of Xerox PARC and 3Com in development of Ethernet.)More on compatibility standards after the break.
Back to Bandwagon Effects –Beta vs. VHS
Bandwagon effect: A benefitthat a person enjoys as others do the same thing that he or she does. In particular, a consumer may enjoy bandwagon effects as others consume the same product or service that he or she does.Bandwagoneffects in high tech industries often have a basis that goes beyond what is in the consumer’s head.Complementarybandwagon effects: Theseapply to products whose value derives, at least in part, from use of competitively supplied complementary products
Beta vs. VHS
“In my opinion, the Sony-developed Beta format is superior to VHS in several ways, including better cassette design, superior tape handling, and overall better video engineering.”-Video expert, Columnist of the journal “Video”But “technical superiority” is not the issue.

By 1980, only a year or so into the battle, VHS had captured nearly 70% of the market. Beta could initially claim the rest, but V2000 arrived to complicate the picture. The first generation of V2000 machines were poorly specified and expensive, so despite its undisputed technical merits the format failed to capture the public imagination.Theivesraiding an electronics warehouse in 1983 cleared out all the VHS and Beta machines, but didn't take a single V2000 deck...
Beta vs. VHS