Demand Theory And Estimation: Network Externality & Bandwagon Effect

Demand Theory and Estimation Name Institution Course Code Date Demand Theory and Estimation Network Effects A network effect or a network externality is the desirable effect that an extra consumer of a good or a service has on the product’s value to others (Chen, 2015). It is simply the additional value of a product due to additional consumers. Hence, the existing consumers benefit in some way when other new individuals start consuming the product. It is also referred to as the demand economies of scale, meaning systems in which the value of each consumer increases as the number of consumers increases (Chen, 2015). The network effects fall into different types including local, two-sided, direct and indirect network effects. A great example of network externality is the bandwagon effect. The bandwagon effect is a phenomenon whereby the quantity demanded for a good or service that a consumer purchase increases in response to the rise in the quantity bought by other customers (Maxwell, 2014). Fashion trends can be well explained by the bandwagon phenomenon. The individual consumption of fashion is mostly in part dependent on the market demand for the product (Maxwell, 2014).However; network externalities can also be adverse. For example, if more and more people buy a given fashion item, then the item tends to go out of style and the demand for it consequently reduces. The negative network externality can be explained as the snob effect (Heineike&Ormerod, n.d) The bandwagon effect makes the demand curve more elastic whereas the snob effect makes the demand curve less elastic (Maxwell, 2014). In addition to the network effect, demand for a product is highly influenced by its price. In the bandwagon effect; the demand curve is completely inelastic at low prices. However; after a given point, the demand curve becomes more elastic despite the price. Chen (2015) describes price elasticities as the responsiveness of the demand for a product in relation to price changes. A unilateral change in the price of a product in the presence of network effects can cause demand transfers between any product pairs. Also, network effects cause a phenomenon whereby the rise in price of a product not to necessarily benefit its substitutes. Chen (2015) concludes that the price elasticity of demand is responsive to the network effect’s size and strength. Explanatory Variables Bellemare, Masaki, and Pepinsky (2017) elucidate explanatory variables as the variables which explain the change in the response variables. T...