Network Externalities: Consumer Irrationality

Producers in different market structures generally have different strategies in terms of pricing, resource allocation and marketing. Often times in an oligopoly or monopolistically competitive market, there will be network externalities present. In other words, the purchasing behavior of consumers affects how much other consumers buy the good. When a positive network externality is present, also called the bandwagon effect, consumers’ perceived purchases and consumption have a direct relationship. A producer who spots potential for, or recognizes the beginning of, a bandwagon effect will likely try and capitalize on the opportunity. While these opportunities may not be very frequent, a successful creation or sustained bandwagon effect can increasingly generate sales. 

There are several steps a producer may take to try and capitalize on a positive network externality. Establishing a unique brand that differentiates a product from its competition allows for customers to quickly recognize the product. A likely result from this is increased perception of market purchases, due to easy recognition of the product when owned by peers.  Another important aspect to consider is influence of your competition on your sales. Often times several producers will simultaneously spot an opportunity for a positive network externality. When this is the case, said competitors will race to have their product become the “market standard,” or dominant product in terms of the bandwagon effect. The incentive to “win” the race is enormous, due to a couple factors. First, succeeding in creating a bandwagon effect for one’s product is likely to continuously increase market share along with profits. Second, competitors who fall short to the successful producer are likely to lose many of their sales to bandwagon effect. To further mass perception of a product as “the product to have, since everyone does” a producer may allocate a fair portion of his marketing budget to create such an image. If marketing is successful, perceived market purchases of that producer’s product will have risen – ultimately increasing sales if a positive network externality is present.  This example is one of many that illustrate how irrational consumer behavior can be manipulated to generate increased sales.