Regulation and the Performance of Communication and Information Networks

Regulation and the Performance of Communication and Information Networks

Edited by Gerald R. Faulhaber, Gary Madden and Jeffrey Petchey

Digital markets worldwide are in rapid flux. The Internet and World Wide Web have traditionally evolved in a largely deregulated environment, but recently governments have shown great interest in this rapidly developing sector and are imposing regulations for a variety of reasons that are changing the shape of these industries. This book explores why the industrial organization of broadband ISPs, Internet backbone providers and content/application providers are in such turmoil.

Chapter 7: Pricing of Complements and Network Effects

Nicholas Economides and Brian Viard

Subjects: innovation and technology, technology and ict

Extract

Nicholas Economides and Brian Viard INTRODUCTION This study examines a monopolist of a base good that benefits from a complementary good provided by either it or another firm. Use of the complementary good requires the base good, but not the reverse. The model assesses and calibrates the extent of the positive influence on the base good profits that is created by the existence of the two sources (internal or external) of the complementary good. An equivalence between a model of a base and complementary good, and a reduced-form model of the base good where network effects are assumed in the utility function as a surrogate for the presence of direct network effects (i.e., a consumer’s utility directly increases in the number of users) or indirect network effects (i.e., arising from increased variety of complementary goods produced by other firms) is established. This allows us to examine the pricing of the complementary good under different market structures and in the context of the effect of other complementary goods via the network effects. Additionally, the study assesses and calibrates the influence of the intensity of network effects and quality improvements in the complementary good on profits from the base good. Also evaluated is the incentive that a monopolist has to improve the quality of the base good rather than that of a complementary good that it produces. The model has implications for the base good monopolist’s trade off in improving the quality of its own complementary good versus subsidizing increases in other...

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