We are grateful to M.Slade and M.Waterson for helpful comments and discussions. A version of the paper was written when the second author was visiting the Centre for Development Economics, Delhi School of Economics. 1 This paper models interaction between groups of agents by means of a graph where each node represents a group of agents and an arc represents bilateral interaction. It departs from the standard Katz-Shapiro framework by assuming that network benefits are restricted only amongst groups of linked agents. It shows that even if rival firms engage in Bertrand competition, this form of network externalities permits strong market segmentation in which firms divide up the market and earn positive profits
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