We first consider a world consisting of two countries, each of which has a fixed endowment of resources which, in turn, can be used for producing goods or network related services. Services are consumed via a network, and involve no cross border payment, since services are purchased and consumed by senders of messages along the network5. They directly enter the sender’s utility function as an argument; but they also provide utility to the receiver, and hence messages sent by others also appear in the utility function of the receiver. It is this feature which generates network externalities, since service recipients make no payment for incoming messages (calls) even though they receive a welfare benefit. The word externality in such situations denotes a consumption to consumption externality in the sense of Meade (1952); here the physical interdependence via message flows to recipients is not appropriately priced.
We use a transformation frontier to describe the technology which allows goods and services in each country to be produced from resource endowments,
where P is the common cross country price of goods, and P„ is the price of network related services in country n. No direct international trade in services occurs; senders pay for such services in their country of origin, and the prices of services can thus differ between the countries. The transformation frontier (1), along with (2), yields an implicit supply function for goods and services in each country.
We assume that there are T\ households in country 1, and T2 in country 2. Each household in each country derives utility directly from consumption of goods and from sending messages along the network (services). When connected to a service network, households also receive additional utility benefits from the services consumed by others in home and foreign countries, since they are the recipients of messages. We assume such benefits are proportional to the total volume of messages sent along the network; since as the total message volume expands so does the potential number of callers that could be in contact with any particular recipient.