I compare the incentives firms have to produce individual components compatible with components of other manufacturers instead of "systems" composed of components that are incompatible with components of competing manufacturers. I show that, even in the absence of positive consumption externalities ("network" externalities), prices and profits will be higher in the regime of compatibility. Equilibrium total surplus could be higher in either regime. Both regimes overprovide variety compared to the surplus-maximizing solution.

Liquidity considerations will limit the number of markets in a competitive economy. Welfare implications are ambiguous. Since liquidity is a positive externality, there may be too little liquidity per market at a noncooperative equilibrium and too many markets compared to the surplus-maximizing market structure. But liquidity is also self-reinforcing. Given an existing equilibrium, new markets may not open because nobody wants to use a new market with low liquidity. There may be too few markets to achieve efficiency and new markets will not open. A nondiscriminating monopolist will operate smaller and more numerous markets compared to optimality as well as to the equilibrium of independent auctioneers.

The author compares the incentives firms have to produce individual components compatible with components of other manufacturers instead of "systems" composed of components that are incompatible with components of competing manufacturers. He shows that, even in the absence of positive consumption externalities (" network" externalities), prices and profits will be higher in the regime of compatibility. Equilibrium total surplus could be higher in either regime. Both regimes overprovide variety compared to the surplus-maximizing solution. Copyright 1989 by American Economic Association.

Liquidity considerations will limit the number of markets in a competitive economy. Welfare implications are ambigious. Since liquidity is a positive externality, there may be too little liquidity per market at a noncooperative equilibrium and too many markets compared to the surplus-maximizing market structure. But liquidity is also self-reinforcing. Given an existing equilibrium, new markets may not open because nobody wants to use a new market with low liquidity. There may be too few markets to achieve efficiency. A nondiscriminating monopolist will operate smaller and more numerous markets compared to optimality as well as to the equilibrium of independent auctioneers. Copyright 1988 by American Economic Association.