Two is enough: a flip on Bertrand through positive network effects

Abstract

We discuss price competition when positive network effects are the only other factor in consumption choices. We show that partitioning consumers into two groups creates a rich enough interaction structure to induce negative marginal demand and produce pure price equilibria where both firms profit. The crucial condition is one group has centripetal influence while the other has centrifugal influence. The result is contrary to when positive network effects depend on a single aggregate variable and challenges the prevalent assumption that demand must be micro-founded on a distribution of consumer characteristics with specific properties, highlighting the importance of interaction structures in shaping market outcomes.