Put simply, the network effects occur as higher benefits are enjoyed for each user when the network of users increases. The implication of network effects, however, would also be a disincentive for any individual to be the first adopter of the new technology in which network effects occur. Even if you had all the knowledge and expertise to build a chat platform, it's hard to encourage users to adopt your new platform in the short term. Moreover, the second implication of network effects is that, if two versions (or more) of the typical technology are substitutable, then the one with the higher number of users will have a better position, even if it is less inefficient or its competitor has better quality -- commonly referred as winners-take-all competition.
To see this winners-take-all competition more clearly, take Sony vs JVC as an example. Sony's Betamax format was considered better than JVC's VHS in terms of picture and sound quality. However, Sony made a mistake in the early 1980s by restricting the recording time to only 60 minutes. This meant that if customers wanted to record a full-length movie using their Betamax, they had to change the tape in the middle of the recording. By the time Sony increased the recording length to 120 minutes, VHS had gained a much larger user base, causing the Betamax format to practically vanish.
However, many economists are currently concerned about the winner-take-all market outcome. The high reward enjoyed by only the "winners" of the market would lead to the concentration of wealth. This would eventually lead to higher inequality and inefficiency as the economy experienced "inequality of opportunity".Â
The Role of Intellectual Property Rights: Invention vs Diffusion
As we all know, intellectual property rights take the role as protection of codifiable (means can be written down) and non-excludable (the use by others cannot be prevented) knowledge, with three most common forms: patents, trademarks, and copyright. All of these forms of intellectual property rights possess the same characteristic: The owner is given the exclusive rights to use the protected item for a specific period of time, creating a temporary monopolist.
Do intellectual property rights encourage or actually discourage innovation?
To answer this question, we must consider the two opposite implications:
The incentive for Research and Development: The intellectual property rights would make the owner enjoy economic profits (called innovation rents), creating a temporary monopolist, and thus encourage other economic agents doing more R&D to also enjoy the innovation rents
The barrier to new innovation and diffusion: The rights, however, would limit the adaptation of the innovation throughout society (called diffusion) and also limit the others to make improvements from any given products protected by the rights.
Look at the crucial innovation of history (pioneer of the first industrial revolution), the steam engine by James Watt which was patented in 1769, and later on a share in the patent was bought by Matthew Boulton. However, the patent was also used to prevent other steam engine designs -- such as Jonathan Hornblower's design -- which was more efficient than the Watt. Moreover, the United Kingdom experienced a significant increase in the installation of steam engines after the Watt-Boulton patent expired. While under Watt's patent, the country added around 750 horsepower of steam engines per year. However, in the 30 years following the expiration of the patent, England saw an annual installation of over 4,000 horsepower of steam engines. Notably, fuel efficiency, which had seen minimal improvement during the patent period, multiplied by five between 1810 and 1835 (Boldrin and Levine, 2010).
Another unique piece of evidence would be the Italian operas. The establishment of copyright protection in Lombardy and Venetia -- due to Napoleon's military victories -- for Italian operas in the 19th century would encourage more artistic creativity, implying the creation of more and better operas, compared to six other Italian states without copyrights. However, Petra Moser (2020) also presents evidence that Opera's copyright with a short-lived duration and narrow scope is more favorable than the one with too broad or too long-term intellectual property rights -- which may do "more harm than good".
