competing for monopoly: the economics of network...
TRANSCRIPT
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Third Edition
Competing for Monopoly: The Economics of Network Goods
Competing for Monopoly: The Economics of Network Goods
Chapter 16
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Outline
� Network goods are usually sold by monopolies and oligopolies.
� The “best” products may not always win.
� Competition is “for the market” instead of “in the market”.
� Antitrust and network goods.
� Music is a network good.
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Introduction
� As of 2014, there were 1.4 billion active users on Facebook.
� Match.com, the largest internet dating service, has over 20 million users.
� Facebook and Match.com are examples of network goods.
� The value to a user depends on how many other people use it.
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Definition
Network good:
a good whose value to one consumer
increases the more other consumers
use the good.
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Self-Check
Which of the following is a network good?
a. Chairs used in a classroom.
b. Software used to create and read documents.
c. Chocolate chip cookies.
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Answer: b
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Markets for Network Goods
Features:
1. Usually sold by monopolies or oligopolies.
2. The “best” product may not always win.
3. Competition is “for the market” instead of “in the market”.
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Markets for Network Goods
1. Sellers are Oligopolies or Monopolies
� Most people want to use software that is compatible with others
� Pressure of coordination creates a near-monopoly
�Example: Microsoft
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Markets for Network Goods
1. Sellers are Oligopolies or Monopolies
� Sometimes more than one firm can compete on different features, specialized niches
�Examples: Match.com, Jdate.com, OKCupid, eHarmony
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Self-Check
Why are network goods usually sold by monopolies or oligopolies?
a. Pressure to be compatible.
b. Pressure to be the cheapest.
c. Pressure to provide the best product.
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Answer: a
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Markets for Network Goods
2. Best Product May not Win
� A market may lock in on an inferior product or network
� Lock-in can be shown with a coordination game
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Definition
Coordination Game:
A game in which the players are better
off if they choose the same strategies,
but there is more than one strategy on
which to coordinate.
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Coordination Game
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
Alex and Tyler can choose either Apple or Microsoft software
Alex’s choices are the rows.
Tyler’s choices are the columns.
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Coordination Game
Alex’s payoff
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
Tyler’s payoff
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Coordination Game
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
If they use different software, it is difficult to work together (low payoffs).
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Coordination Game
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
If they use the same software, it is easier to work together (high payoffs).
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Coordination Game
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
If both choose the same software, neither has an incentive to change.
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Definition
Other examples in standards wars:
VHS vs Betamax
Blu-Ray vs HD_DVD
Before the Blu-Ray standard was adopted, the benefits of the market were largely unrealized
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Sony
HD-DVD Blu-Ray
ToshibaHD-DVD (10, 8) (0, 0)
Blu-Ray (0, 0) (8,10)
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Definition
Nash Equilibrium:
A situation in which no player has an
incentive to change his or her strategy
unilaterally.
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Coordination Game
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Tyler
Apple Microsoft
AlexApple (11, 11) (3, 3)
Microsoft (3, 3) (10, 10)
With TWO equilibria, the choice is often determined by “accidents of history”.
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Nash Equilibrium
Cell Phone Duopoly
� Smalltown has 140 residents
� The “good”: cell phone service with
unlimited anytime minutes and free
phone
� Smalltown’s demand schedule at left
� Two firms: T-Mobile, Verizon
(duopoly: an oligopoly with two firms)
� Each firm’s costs: FC = $0, MC = $1020
P Q
$0 140
5 130
10 120
15 110
20 100
25 90
30 80
35 70
40 60
45 50
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Nash Equilibrium
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Competitive outcome:
P = MC = $10
Q = 120
Profit = $0
Competitive outcome:
P = MC = $10
Q = 120
Profit = $0
Monopoly outcome:
P = $40
Q = 60
Profit = $1,800
Monopoly outcome:
P = $40
Q = 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 � P = $35
Verizon profit = TR – TC = 40*$35 - ($10* 40) = $1000
T-Mobile profit = (30*$35) – ($10*30) = 750
Verizon gains profit, T-Mobile loses profit
Will Verizon cheat? Why wouldn’t they? Profits increase22
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Nash Equilibrium
What will T-Mobile do in response? Will it gain if it cheats?
Suppose T-Mobile increases its Q to 40
Now market Q = 80 and market price falls to $30
What is T-Mobile’s profit? (40*$30) – (40*10) = $800
Will T-Mobile increase its Q?
Yes, since its profits increase from $750 to $800
Note that Verizon’s profits fall from $1000 to $800
Verizon cheats and increase profits, T-Mobile profits fall
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Nash Equilibrium
�Is there an incentive to cheat at this point?
�Suppose Verizon increases output to 50Q
�Market Q rises to 90 and market price falls to $25
�What is Verizon’s profit?
• (50 * $25) – (50 * $10) = $750 (down from $800)
�Does Verizon have any incentive to cheat? No
�Does T-Mobile have any incentive to cheat? No
�What if either company cuts production to 40Q?
�Both companies are worse off if they move away from producing 40Q.
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Nash Equilibrium
Verizon and T-Mobile are now at a Nash equilibrium
A Nash equilibrium is a situation in which no player has an incentive to change their strategy unilaterally
� By cooperating (30 Q each) they could have made more profit
� Both companies are in a less profitable position
� Prisoner’s dilemma
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Markets for Network Goods
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� The current QWERTY keyboard may not be the best design
� QWERTY came first and got locked in
The Dvorak keyboard, developed in the 1930s
TOSHIK/SHUTTERSTOCK
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Markets for Network Goods
Product Design in Network Markets:
� Ensure product fits into rest of the market
� Make it easy to use for as many people as possible
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Self-Check
When there are two equilibria in a network market, the winner is usually decided by:
a. Democratic vote.
b. Who produces at the lowest cost.
c. Accidents of history.
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Answer: c
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Markets for Network Goods
3. Competition “for the market”
� Consumer loyalties can switch quickly
� A monopoly can easily change hands
� 1988: Lotus 1-2-3 had 70% of the spreadsheet market
� 1998: Excel had 70% of the market
� Results in serial monopolies
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Definition
Contestable Market:
A market in which the threat of potential
competition is enough to make it
behave competitively.
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Contestable Market:
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.
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Contestable Market:
� Large market share does not necessarily mean the firm’s position is safe…
� How contestable is Facebook’s market?
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Self-Check
Which of the following is most likely to operate in a contestable market?
a. Railroad.
b. Pharmaceutical company.
c. Restaurant.
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Answer: c
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Markets for Network Goods
3. Competition “for the market”
� In a contestable market, a new competitor could take away business
� This threat forces firms to make choices in light of potential competition
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Switching Costs
� Incumbent firms often try to limit the contestability of the market
� One way is to increase switching costs
• Example: Apple makes it easy to download content to iPad
• Difficult to export to other systems
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Antitrust
Regulating Network Markets:
� Market for network goods will be dominated by a few firms
� Not monopoly vs. competition, but one monopoly vs. another
� Important that competition for the market is not impeded
� Normal market share percentages analysis does not apply
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Music is a Network Good
� The more downloads a song has, the more people want to download it
� Bands often get popular quickly
� Popularity feeds on itself even if they’re not the “best”
� Easily dethroned by the next new band
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Takeaway
� Network goods are usually sold by monopolies or oligopolies
� Sometimes customers will get locked in to the wrong network
� There is a coordination problem in switching from one network to another
� Contestable markets force incumbents to act competitively
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