Nicholas Economides

COMPETITION AND INTEGRATION AMONG COMPLEMENTS, AND NETWORK MARKET STRUCTURE*

This article analyzes the competition and integration among complementary products that can be combined to create composite goods or systems. The model generalizes the Cournot duopoly complements model to the case in which there are multiple brands of compatible components. It analyzes equilibrium prices for a variety of organizational and market structures that differ in their degree of competition and integration. The model applies to a variety of product networks, including automatic teller machines, real estate multiple listing services, and airlines CRS, as well as to nonnetwork markets of compatible components such as computer CPUs and peripherals, hardware and software, and long distance and local telephone services. Copyright 1992 by Blackwell Publishing Ltd.

Network Neutrality on the Internet: A Two-Sided Market Analysis

We discuss network neutrality regulation of the Internet in the context of a two-sided market model. Platforms sell broadband Internet access services to residential consumers and may set fees to content and application providers on the Internet. When access is monopolized, cross-group externalities (network effects) can give a rationale for network neutrality regulation (requiring zero fees to content providers): there exist parameter ranges for which network neutrality regulation increases the total surplus compared to the fully private optimum at which the monopoly platform imposes positive fees on content providers. However, for other parameter values, network neutrality regulation can decrease total surplus. Extending the model to a duopoly of residential broadband ISPs, we again find parameter values such that network neutrality regulation increases total surplus suggesting that network neutrality regulation could be warranted even when some competition is present.

Symmetric equilibrium existence and optimality in differentiated product markets

Abstract Equilibrium existence and optimality are analysed in a market for products differentiated by their variety. A game of three stages is analysed. Firms enter in the first stage, choose varieties in the second stage, and choose prices in the third stage. The existence of subgame-perfect equilibria is established. At equilibrium products are symmetrically located in the space of characteristics and are offered at equal prices. The surplus maximizing solution is characterized, and it is shown that surplus maximizing product diversity is lower than the equilibrium one.

MINIMAL AND MAXIMAL PRODUCT DIFFERENTIATION IN HOTELLING'S DUOPOLY

Abstract Hotellings (1929) model of duopolistic competition is re-examined. A family of utility functions is used which has as a special case Hotellings original utility function. In a two-stage location-price game it is shown that an equilibrium exists when the curvature of the utility functions in the space of characteristics is sufficiently high. The (subgame-perfect) equilibrium never exhibits minimum product differentiation. On the other hand, not all equilibria are at maximal product differentiation.

The principle of minimum differentiation revisited

Abstract Hotellings model of differentiated products is examined and modified so that consumers have relatively low reservation prices for the differentiated products. The problem of existence of a Nash equilibrium in prices in a duopoly with given products is analysed. When the reservation price is relatively low, a Nash equilibrium in prices exists for a larger range of products than when the reservation price is infinite. Next I examine product competition with instantaneous adjustment to the Nash equilibrium prices of the previous game. Firms competing in a Nash fashion have tendencies to move away from each other and try to achieve ‘local monopolistic’ positions. This is in sharp contrast with the acclaimed ‘Principle of Minimum Differentiation’ of the original model of Hotelling (of high reservation price) where firms clustered in the product space.

Networks and compatibility: Implications for antitrust

In this paper we draw crucial parallels between the concepts of compatibility and networks and the more traditional concepts of complementarity and vertical relationships. We also develop the important distinctions between ‘two-way networks’ and ‘one-way networks’. We then apply our framework to a number of current antitrust issues.

QUALITY VARIATIONS AND MAXIMAL VARIETY DIFFERENTIATION

We allow quality variations in a duopoly of locationally differentiated products a-la-Hotelling (1929). We analyze the impact of quality variations on the choices of the varieties produced. We show that in a sequential game of variety choice and subsequent quality and price choice there exist only maximal variety differentiation equilibria in pure strategies. Maximal variety differentiation is also the perfect pure strategies equilibrium of a sequential game of variety choice followed by quality choice and later by price choice. In both games there is minimal quality differentiation at equilibrium.

The Economics of Network Neutrality

Pricing of Internet access has been characterized by two properties. Parties are directly billed only by the Internet Service Provider (ISP) through which they connect to the Internet and the ISP charges them on the basis of the amount of information transmitted rather than its content. These properties define a regime known as “network neutrality.” In 2005, some large ISPs proposed that application and content providers directly pay them additional fees for accessing the ISPs’ residential clients, as well as differential fees for prioritizing certain content. We analyze the private and social incentives to introduce such fees when the network is congested and more traffic implies delays. We find that network neutrality is welfare superior to bandwidth subdivision (granting or selling priority service). We also consider the welfare properties of the various regimes that have been proposed as alternatives to network neutrality. In particular, we show that the benefit of a zero-price “slow lane” is a function of the bandwidth the regulator mandates be allocated it. Extending the analysis to consider ISPs’ incentives to invest in more bandwidth, we show that, under general conditions, their incentives are greatest when they can price discriminate; this investment incentive offsets to some degree the allocative distortion created by the introduction of price discrimination. A priori, it is ambiguous whether the offset is sufficient to justify departing from network neutrality.

Quality choice and vertical integration

We show that, despite coordination in the quality level of the components that they provide, independent vertically-related (disintegrated) monopolists will provide products of lower quality level than a sole integrated monopolist. Further, the integrated monopolist achieves higher market coverage, higher consumer surplus, and higher profits.We establish these results for any distribution of preferences in the standard model of quality differentiation. Despite the lower quality, we also show that, for a wide class of cost functions, price will be higher in a market of independent vertically-related monopolists. All results are the effects of the interaction of double- marginalization, occurring in the market of independent monopolists, with the choice of quality.

'Net Neutrality', Non-Discrimination and Digital Distribution of Content Through the Internet

The vast majority of US residential consumers face a monopoly or duopoly in broadband Internet access. Up to now, the Internet was characterized by a regime of “net neutrality” where there was no discrimination in the price of a transmitted information packet based on the identities of either the transmitter or the receiver or based on the application or type of content that it contained. The providers of DSL or cable modem access in the United States, taking advantage of a recent regulatory change that effectively abolished net neutrality and non-discrimination protections, and possessing significant market power, have recently discussed implementing a variety of discriminatory pricing schemes. This paper discusses and evaluates the implication of a number of these schemes on prices, profits of the network access providers and those of the complementary applications and content providers, as well as the impact on consumers. We also discuss an assortment of anti-competitive effects of such price discrimination, and evaluate the possibility of imposition of net neutrality by law.