Network Externality, Product Differentiation and Social Welfare: the Market of Information Goods (Research Seminar, May 2nd, 2002) Bing Jing New York University Abstract Looking at the interactions between network externality (which is a demand-side phenomenon) and product quality (a supply-side factor), this study examines how externalities affect firms’ product differentiation and the resulting social welfare under two alternative market structures: a monopoly and a duopoly. With network externality, a monopolist has an incentive to extend the length of its product line; market segmentation becomes optimal in that the monopolist chooses two distinct qualities demonstrating maximum differentiation. Furthermore, marginal-cost pricing occurs for the lower quality when the admissible quality range is sufficiently wide. Equilibrium quality choices in a duopoly are characterized. A key result of this research is that, in vertically differentiated network markets, a monopoly may generate higher social welfare than a duopoly.