New Firm Entry in the Presence of Network Effects

Abstract

We show that in the presence of network effects, the effect of new firm entry on the equilibrium prices and demands of incumbent firms is not clear. In contrast to conventional thinking, we find that incumbent firms could use a higher price, have a larger demand, and earn a higher profit in the new Nash equilibrium. These perverse results arise from the fact that in the event of new firm entry, network effects can create unbalanced demand transfers between incumbent firms, and some incumbent firms can actually benefit from new entry.