Re: Krugman on Gould, et al.

Robin Hanson (
Thu, 04 Mar 1999 09:21:01 -0800

On 3/4/99, Tom O. Morrow wrote:
>I'd criticized Krugman's analysis of network effects both for using the wrong
>terminology (calling it "externalities") and for failing to adequately
>accomodate new evidence regarding the QWERTY myth. Robin Hanson wrote:
>>Searching for "Liebowitz Margolis network effects" at AltaVista gets me this
>>10/98 CATO policy analysis:]
>>... These authors don't complain about the phrase "network externality",
>>and I see no reason to complain either.
>The criticisms of those authors regarding the misnomer "network externalities"
>comes in other, earlier work. I believe that it is available online, via one
>or both of the author's academic homepages, ...

Liebowitz's net papers are at and the closest thing seems to be whose abstract is:

>This article in combination with our paper "Are Network Externalities a
>New Source of Market Failure" has had important impacts in the network
>externality literature. Katz and Shapiro, in response to our work, have
>adopted our term "network effect" instead of the policy-pejorative term
>"network externality". Also, they accept our point that pecuniary
>externalities, which are importantly different from technological
>externalities, have been conflated in this literature, and need to be
>treated differently. Although, Katz and Shapiro have changed some of
>their positions to accommodate our criticisms, we would have been happier
>if they had been willing to acknowledge their debt to our work.

In the paper they say:

>Broadly defined, network effects are indeed pervasive. However, we reserve
>the term "network externality" for a specific kind of network effect in
>which the equilibrium exhibits unexploited gains from trade regarding
>network participation. The advantage of this definition over other
>possible definitions is that it corresponds with the common understanding
>of externality as an instance of market failure.

I actually strongly disagree with this attitute toward terminology. In economic theory we build models from standard components and see what the combination of those components does in any given situation. We need a terminology for descibing components that makes no presumptions about the effect of some combination.

"Externality" describes a specific kind of assumption/feature one might put into a model. The existance of market failure is a property of a whole specific model. It is crucial that we can agree on what a term like "externality" means about the assumptions of a model, without that implying anything about whether that model describes a market failure.

Substituting the word "effect" is far too weak. If we did this with every term we wouldn't be left with a vocabulary that let's us distinguish anything interesting.

To sum up, there is no common understanding that externalities imply market failure. If I saw externalities in a model, that might suggest to me, all else equal, that this model might be more likely to exibit market failure. But is just a heuristic, and has nothing to do with what the term "externality" means.

Robin Hanson   
RWJF Health Policy Scholar             FAX: 510-643-8614 
140 Warren Hall, UC Berkeley, CA 94720-7360 510-643-1884 after 8/99: Assist. Prof. Economics, George Mason Univ.