Nonlinear pricing and type-dependent network effects

Abstract

This paper analyzes optimal monopoly pricing under incomplete information for a good that displays positive network effects. In contrast with standard models of network effects (Katz and Shapiro, 1985), the good modeled in this paper is consumed in variable quantities by heterogeneous customers, and the magnitude of the network effects therefore depends on the total quantity consumed across customers, rather than the total number of adopters. In addition, the value each customer gets on account of the network effects depends on the customer’s individual consumption, as well as the customer’s type. Examples of products that fit this description at least partially include corporate desktop software (where customers are corporations of varying sizes, with varying intensity of software usage across employees) and online trading services (such as those offered by eBay, where network effects increase with increased trading volume).