1. Competing for Monopoly: The Economics of Network Goods
Chapter 16
Competing for Monopoly: The Economics of Network Goods

2. 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.

3. 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.

4. Definition Network good:
a good whose value to one consumer increases the more other consumers use the good.

5. Self-Check Which of the following is a network good?
Chairs used in a classroom.
Software used to create and read documents.
Chocolate chip cookies.
Answer: b

6. Markets for Network Goods
Features:
Usually sold by monopolies or oligopolies.
The “best” product may not always win.
Competition is “for the market” instead of “in the market”.

7. 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

8. 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

9. Self-Check
Why are network goods usually sold by monopolies or oligopolies?
Pressure to be compatible.
Pressure to be the cheapest.
Pressure to provide the best product.
Answer: a

10. 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

11. 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.

12. Coordination Game Tyler Alex Apple Microsoft (11, 11) (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.

13. Coordination Game Tyler Alex Apple Microsoft (11, 11) (3, 3) (10, 10)
Alex’s payoff
Tyler’s payoff

14. Coordination Game Tyler Alex Apple Microsoft
(11, 11)
(3, 3)
(10, 10)
If they use different software, it is difficult to work together (low payoffs).

15. Coordination Game Tyler Alex Apple Microsoft
(11, 11)
(3, 3)
(10, 10)
If they use the same software, it is easier to work together (high payoffs).

16. Coordination Game Tyler Alex Apple Microsoft
(11, 11)
(3, 3)
(10, 10)
If both choose the same software, neither has an incentive to change.

17. Definition Other examples in standards wars: VHS vs Betamax
Sony
HD-DVD
Blu-Ray
Toshiba
(10, 8)
(0, 0)
(8,10)
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

18. Definition Nash Equilibrium:
A situation in which no player has an incentive to change his or her strategy unilaterally.

19. Coordination Game Tyler Alex Apple Microsoft
(11, 11)
(3, 3)
(10, 10)
With TWO equilibria, the choice is often determined by “accidents of history”.

20. Nash Equilibrium Cell Phone Duopoly Smalltown has 140 residents$0
140 5
130 10
120 15
110 20
100 25 90 30 80 35 70 40 60 45 50
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 = $10

21. Nash Equilibrium Competitive outcome: P = MC = $10 Q = 120 Profit = $0
Monopoly outcome:
P = $40
Q = 60
Profit = $1,800

22. 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 increase

23. 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

24. 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.

25. 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

26. Markets for Network Goods
TOSHIK/SHUTTERSTOCK
The Dvorak keyboard, developed in the 1930s
The current QWERTY keyboard may not be the best design
QWERTY came first and got locked in

27. 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

28. Self-Check
When there are two equilibria in a network market, the winner is usually decided by:
Democratic vote.
Who produces at the lowest cost.
Accidents of history.
Answer: c

29. Markets for Network Goods
3. Competition “for the market”
Consumer loyalties can switch quickly
A monopoly can easily change hands
1988: Lotus had 70% of the spreadsheet market
1998: Excel had 70% of the market
Results in serial monopolies

30. Definition Contestable Market:
A market in which the threat of potential competition is enough to make it behave competitively.

31. 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.

32. Contestable Market:
Large market share does not necessarily mean the firm’s position is safe…
How contestable is Facebook’s market?

33. Self-Check
Which of the following is most likely to operate in a contestable market?
Railroad.
Pharmaceutical company.
Restaurant.
Answer: c

34. 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

35. 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

36. 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

37. 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

38. 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