Horizontal differentiation model with network externality

This paper analyzes a two stage horizontal differentiation model with network externality. Under duopoly structure, the existence of network externality not only increases consumers' willingness of buying, but intensifies competition between firms as well. The subgame perfect Nash equilibrium is compared with that in quadratic transportation cost Hotelling model. Firms adopt the principle of maximum differentiation when network externality is not too large. Firms' profits and prices decrease with network externality, whereas consumer surplus and social net welfare improve. The duopoly structure cannot exist when network externality is too large. Under monopoly structure with network externality, social net welfare improves owing to high profit of monopolist, whereas consumer surplus remains unchanged.