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Competing for Monopoly: Competing for Monopoly: The Economics of Network The Economics of Network

GoodsGoods

CHAPTER OUTLINE

Network Goods Are Usually Sold by Monopolies and Oligopolies

The “Best” Products May Not Always Win

Standard Wars Are Common

Competition Is “For the Market” Instead of “In the Market”

Contestable Markets

Antitrust and Network Goods

Music Is a Network Good

For applications, click hereTo Try it! To Try it! questionquestion

ss

Some good blogs and other sites to get the juices flowing:

Food for Food for Thought….Thought….

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Network Goods

A Network GoodNetwork Good is a good whose value to one consumer increases the more that other consumers use the good.

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Network Goods

Features of network goods:1. Network goods are usually sold by

monopolies or oligopolies;2. When networks are important the

“best” product may not always win;3. Standard wars are common in

establishing network goods;4. Competition in the market for

network goods is for the market instead of in the market.

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Monopolies and Oligopolies Sell Network Goods

Network goods typically involve one firm providing a dominant standard at a high price.

These markets usually include a number of other firms offering a slightly different product.

These firms tend to service niche areas in the market.

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The “Best” Product May Not Always Win

It’s possible for the market to “lock in” to the “wrong” product.A Nash EquilibriumNash Equilibrium is a situation in which no player has an incentive to change their strategy unilaterally.Tyler

Apple Microsoft

AlexApple (11, 11) (3, 3)

Microsoft (3, 3) (10, 10)

Both (Apple, Apple) and (Microsoft, Microsoft) are Nash Equilibria depending on who chooses what first.If Alex chooses Apple, Tyler faces a better payoff if he also chooses Apple (11) or a lower payoff if he chooses Microsoft (3) and vice versa.

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Standard Wars are Common

Both companies prefer a standard to none…Two Nash equilibria exist…

Postscript: The Sony group won the standard war when Blu-Ray technology was imbedded into the Sony PlayStation 3 and increased the audience for Blu-Ray

Sony

HD-DVD Blu-Ray

ToshibaHD-DVD (10, 8) (0, 0)

Blu-Ray (0, 0) (8,10)

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Competition is “For the Market” instead of “In the Market”

Once there is a winning standard, the loser can disappear quite rapidly.Winners are not guaranteed their victory for long.

1988: Lotus 1-2-3 dominates the market.1998? Excel dominates.

It’s normal for just a few firms to dominate some markets. Does this make us worse off?

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Nash Equilibrium

Cell Phone DuopolyP Q

$0 140

5 130

10 120

15 110

20 100

25 90

30 80

35 70

40 60

45 50

Smalltown has 140 residents

The “good”: cell phone service with unlimited anytime minutes and free phone

Smalltown’s demand schedule

Two firms: T-Mobile, Verizon(duopoly: an oligopoly with two firms)

Each firm’s costs: FC = $0, MC = $10

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Nash Equilibrium

5045

6040

7035

8030

9025

10020

11015

12010

1305

140$0

QP

1,750

1,800

1,750

1,600

1,350

1,000

550

0

–650

–1,400

Profit

500

600

700

800

900

1,000

1,100

1,200

1,300

$1,400

Cost

2,250

2,400

2,450

2,400

2,250

2,000

1,650

1,200

650

$0

Revenue Competitive outcome:

P = MC = $10Q = 120

Profit = $0

Competitive outcome:

P = MC = $10Q = 120

Profit = $0

Monopoly outcome:P = $40Q = 60

Profit = $1,800

Monopoly outcome:P = $40Q = 60

Profit = $1,800

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Nash Equilibrium

T-Mobile and Verizon could agree to each produce half of the monopoly output:

For each firm: Q = 30, P = $40, profits = $900

Does anyone have an incentive to cheat?What if Verizon increases Q to 40?Market demand curve now has Q = 70 and P = $35Verizon profit = Revs – Costs

= 40*$35 - ($10* 40) = $1000T-Mobile profit = (30*$35) – ($10*30) = 750Verizon gains profit, T-Mobile loses profit

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Nash Equilibrium

Will Verizon cheat? Why wouldn’t they?What will T-Mobile do?Will it gain if it cheats?Suppose T-Mobile increases its Q to 40Now market Q = 80 and market price = $30What is T-Mobile’s profit?

(40*$30) – (40*10) = $800

Will T-Mobile increase its Q? Yes, since its profits increase from $750 to $800Note that Verizon’s profits fall from $1000 to $800

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Nash Equilibrium

Is there an incentive to cheat at this point? Suppose Verizon increases output to 50Market Q rises to 90 and market price falls to $25What is Verizon’s profit? (50 * $25) – (50 * $10) = $750Does Verizon have any incentive to cheat? No

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Nash Equilibrium

Verizon and T-Mobile have arrived at a Nash equilibriumDefinition:

A Nash equilibrium is a situation in which no player has an incentive to change their strategy unilaterally

By cooperating they could have made more profitNote that decreasing production yields no gainSo now they are both in a less profitable position

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Do you use Facebook? a)Yes b)NoIf so, how much would you REALLY be willing to pay per month for access to Facebook? (if not, use your best guess)a)$0b)$1.99c)$4.99d)$9.99e)$19.99

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Contestable Markets

Contestable Market: when a competitor could credibly enter and take away business from the incumbent.Large market share does not necessarily mean the firm’s position is safe…

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Contestable Markets

Markets are more contestable when:

1. Fixed costs of market entry are low, relative to potential revenue.

2. There are few or no legal barriers to entry.

3. The incumbent has no unique, hard-to-replicate resource.

4. Consumers are open to the prospect of dealing with a new competitor.

SEE THE SEE THE INVISIBLEINVISIBLE HANDHAND

SEE THE SEE THE INVISIBLEINVISIBLE HANDHAND

City water: less contestable

Mineral water: more contestable

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Limiting Contestability with Switching Costs

Facebook hosts free photos: bad business decision? Or saavy?

If you are embedded with Facebook, are you less likely to switch to another network?

If switching costs rise, demand will be less elastic (and firms can charge more)

http://awkwardfamilyphotos.com/

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Antitrust and Network Goods

Bill Gates testifies before Congress, 1998. Microsoft intended to “smother” Netscape, went to court on antitrust violations and later settled. List three other web browsers that are now popular. Why and how are they thriving?

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Music can be considered a network good in the sense that

a)many people today listen to music online and over computer networks.b)the preferences of individual consumers are independent of what others like.c)music is produced by large networks of bands, record labels, and music stores.d)many consumers prefer to purchase music that others purchase as well. To next To next

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Music Is a Network Good

An ingenious experiment by Duncan J. Watts (Columbia University) demonstrated that tastes in music have a strong social component.

Watts discovered that the more downloads a song had, the more people wanted to download the song.

Try it!Try it!This is the philosopher Rousseau’s “stag hunt game”. He thought many social situations are like going hunting with a friend: If you both agree to hunt for a large male deer (a stag), then you each have to hold your positions near each end of a valley to prevent escape. If one hunter wanders off to hunt the easier-to-find rabbit, then the stag will almost surely get away.

What is the Nash equilibrium (or equilibria) of this game?•(Hunt Stag; Hunt Stag)•(Hunt Rabbit; Hunt Rabbit)•(Hunt Stag; Hunt Rabbit) and (Hunt Rabbit; Hunt Stag)•Both A and B To next To next

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In a “standard war:”

a)there are two good equilibria, but the players differ over which equilibrium is the best.b)there is only one good equilibrium, but players get locked into the “bad” equilibrium.c)the Nash equilibrium never dominates.d)both players would prefer to have no standard. To next To next

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All cartels and cartel-like behavior are illegal in the United Statesa)Trueb)False

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