Abstract: This paper analyzes a two-stage circular model with network externality.The existence of network externality makes firms decrease prices to gain more market shares.The subgame perfect Nash equilibrium shows that consumer surplus and social net welfare improve,and product differentiation moderates.Specially,with strong network externality,monopoly is the social net welfare maximization market structure.

Key words: circular model, network externality, horizontal differentiation, monopolistic competition, monopoly