Monopoly, Quality, and Network Externalities

We describe the behaviour of a monopolist supplying a vertically differentiated good with network externalities. Assuming a fixed cost of quality improvements, we show that the presence of network externalities enhances the incentive to expand output associated with scale economies. Although the quality distortion operated by the monopolist increases with network externalities, the output expansion effect is dominant, so that the welfare loss due to monopoly power shrinks as the role of network externalities in determining consumers’ satisfaction becomes more relevant.