In the case of the fax machine above, and other communication technologies, network externalities arise because as the number of people who use the technology grows, the number of potential conversations increases. In fact, if you have N owners of the technology, there are roughly N 2 potential conversations, which means that if you double the number of owners you get a four-fold increase in the number of potential conversations. Another source of network externalities is when technologies require a shared infrastructure. Or, consider the benefits of adopting, say, a new computer operating system like Linux. As the number of users increases, hardware vendors become more willing to preinstall the software on new machines, software developers are more willing to write new programs, and users are more likely to be able to get help from friends.
Network externalities can also occur on the production side of a market.
Consider the delivery of electricity to a town. Providing electricity to the first house is very expensive, as you have to build a generating plant and string up wires. Of course, the costs of adding a second house to the network are very low, as all you need to do is string a new wire off of the existing wire. Similarly, once you have a network of delivery trucks visiting a large number of neighborhoods, it is very inexpensive to add a new house to the route. In the experiment we explore the impact of a positive consumption network externality.