Networks play an important role in the modern economy. It enters almost every area of the economy such as transportation, telecommunication, information, and electricity, and so on. Some networks grow very fast. For instance, it was estimated that the world information technology market grew, on average, two times faster than the gross domestic product between 1987 and 1994 (Koski, 1998). In July 1994, there were 3.2 million host computers connecting the Internet. This figure increased to 12.9 million in 1996 and 16.1 million, in 1997.
A salient characteristic called network effect or network externality prevails in such industries. It is so critical that it has attracted a lot of attention in the economic literature, recently. Among them, the software industry has also been treated as network (Lange, etc., 2001, Cottrel and Koput, 1998, Katz and Shapiro, 1994) and software market exhibits network externality or effect.
An operating system is a very important kind of system software in the microcomputer. Microsoft Windows has almost monopolized the operating system market since the later 1980s. Linux has recently entered this market and attracted a lot of attention in the last decade. In this thesis, we try to understand the network externality in the operating system market and investigate the effects of government intervention in the operating system market.
We summarize the main results of our analysis as the following:
In Section 1, we first review some important concepts about network. The essential characteristic is the independence among network components, which results in network effect. The network effect of operating system results from its installed bases and the availability and variety of applications running on it. An important issue concerning network effects of operating system is the expectations from both consumers and software developers. Because of their seminal contribution in network economy, we pay special attention on Katz and Shapiro s (1985) research.
In Section 2, we describe the current operating system market around the world. The Microsoft s antitrust case and Linux upstart has attracted a lot attention from the public media. The NSAKey, National Security Agency Key issue found in Microsoft s product worries the Chinese government. For the sake of its information security, the Chinese government makes an effort to establish Linux as an alternative operating system to Microsoft Windows and overcome over dependence its information industry on Microsoft Windows. In the presence of network effects, it is not an easy job since Microsoft has over 80 percent market share in the operating system market while Linux market share is less than 5 percent. Microsoft dominance in the operating system market is a real obstacle for Linux entrance into this market even with the Chinese government intervention.
In Section 3, we use de Palma and Leruth s model to study the operating system market. We show that Microsoft has no incentive to provide two incompatible operating systems when it monopolizes the market. Under the incompatibility assumption, we analyze a situation where Microsoft and Linux duopolize the market and show that Linux survives in the operating system market and earns tiny profit. Due to the network effects, total social welfare is greater in the monopoly case than when there are two incompatible operating system competing. It seems that the society prefers a larger network of operating system rather than two incompatible smaller networks in the presence of network effects.
In Section 4, we extend de Palma and Leruth s model by introducing a variable to study the impact of the Chinese policy on the operating system market. The policy variable directly changes user s valuation of the network externality. With the Chinese government intervention in the operating system market, the market structure changes to some extent. With the government support, Linux increases its importance as an alternative operating system to Microsoft Windows. The government intervention improves the consumers surplus of using either Microsoft Windows or Linux operating system and enhances the profit earned by Linux at the cost of Microsoft s profit loss. However, the gains for consumers and Linux producers cannot offset Microsoft s profit loss. As a result, the total social welfare decreases invariably with the government increasing intervention in the operating system market.
Section 5 summarizes the main results of our thesis and indicates that it is a limitation of our analysis in that we derive our conclusions from a specific