16 CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL Competing for Monopoly: The Economics of Network Goods

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 herehere

Some good blogs and other sites to get the juices flowing: Food for Thought….

B ACK TO Network Goods Network Good A Network Good is a good whose value to one consumer increases the more that other consumers use the good.

B ACK TO 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.

B ACK TO 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.

B ACK TO The “Best” Product May Not Always Win It’s possible for the market to “lock in” to the “wrong” product. Nash Equilibrium A Nash Equilibrium is a situation in which no player has an incentive to change their strategy unilaterally. Tyler AppleMicrosoft Alex Apple(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.

B ACK TO 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-DVDBlu-Ray Toshiba HD-DVD (10, 8)(0, 0) Blu-Ray (0, 0)(0, 0)(8,10)

B ACK TO 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 dominates the market. 1998? Excel dominates. It’s normal for just a few firms to dominate some markets. Does this make us worse off?

B ACK TO Nash Equilibrium Cell Phone Duopoly PQ $  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

B ACK TO Nash Equilibrium $0 QP 1,750 1,800 1,750 1,600 1,350 1, –650 –1,400 Profit ,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, $0 Revenue 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

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

B ACK TO 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 40 Now market Q = 80 and market price = $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

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

B ACK TO Nash Equilibrium Verizon and T-Mobile have arrived at a Nash equilibrium Definition: 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 profit Note that decreasing production yields no gain So now they are both in a less profitable position

Do you use Facebook? a)Yes b)No If so, how much would you REALLY be willing to pay per month for access to Facebook? (if not, use your best guess) a)$0 b)$1.99 c)$4.99 d)$9.99 e)$19.99

B ACK TO 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…

B ACK TO 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 INVISIBLE HAND City water: less contestableMineral water: more contestable

B ACK TO 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)

B ACK TO Antitrust and Network Goods Bill Gates testifies before Congress, 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?

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.

B ACK TO 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.

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? a)(Hunt Stag; Hunt Stag) b)(Hunt Rabbit; Hunt Rabbit) c)(Hunt Stag; Hunt Rabbit) and (Hunt Rabbit; Hunt Stag) d)Both A and B

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.

All cartels and cartel-like behavior are illegal in the United States a)True b)False B ACK TO