1. 1 Stephen M. Maurer Goldman School of Public Policy IT and Public Policy – Oct. 21, 2004

2. 2 Motivating Examples: TCP/IP & Berkeley Unix GSM The Web The Browser Wars etc., etc., etc… Introduction

3. 3 Old Economy Externalities Pollution (Negative) Flower Gardens (Positive) Network Externalities “ I Care If You Use It” How Big Should the Network Be? Lawyers & WordPerfect... Introduction

4. 4 1. Direct Network Externalities MS Word 2.Indirect Network Externalities Operating Systems & Games 3.Physical Network Externalities Internet & Telephones Introduction

5. 5 W (p) Price Users Old Economy Direct S(p) D = w(p)

6. 6 W (p) Price Users Old Economy Direct W’ (p) S(p) Shifting Demand

7. 7 New Economy “I Care if You Use It” D = w(p, n) Multiple Demand Curves Implications for Efficiency Direct

8. 8 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users Demand Direct

9. 9 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users Competition Notes: Self-Consistency Multiple Equilibria P = MC n1n1 n2n2 n3n3 Direct

10. 10 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users n1n1 n2n2 n3n3 Monopoly MC Direct

11. 11 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users n1n1 n2n2 n3n3 Monopoly MC Direct

12. 12 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users n1n1 n2n2 n3n3 Monopoly MC Direct

13. 13 Tactics User Networks Penetration Pricing Consumers Expectations Hype Vaporware Attack Ads Direct

14. 14 Tactics Commitment Strategies Second Sources Intel, IBM PC Renouncing Monopoly Netscape Navigator Investments & Alliances The PC Reputation Direct

15. 15 Tipping Direct Network Effects The Best Product Doesn’t Always Win! VHS vs. Beta R&D Effects Appropriability Increased Demand

16. 16 Tipping Direct

17. 17 Efficiency Static Efficiency The Old Economy Answer How Big Should The Network Be? Which Institution Comes Closest? Dynamic Efficiency Lock-In vs. Stranding Direct

18. 18 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users n1n1 n2n2 n3n3 Efficiency MC Direct

19. 19 W (p, n 1 ) W (p,n 2 ) W (p,n 3 ) Price Users n1n1 n2n2 n3n3 Efficiency MC Direct

20. 20 Efficiency Monopoly vs. Competition Network Externalities Price & DWL Variety Economies of Scale & Duplicated R&D Is The Competitive Solution Ideal? Direct

21. 21 Efficiency Stranding vs. Lock-In Switching Costs Coordination Problems Aggressive Pricing Beta vs. Leaded Gasoline Direct

22. 22 Efficiency Open Standards “Look and Feel” Ex Ante vs. Ex Post Efficiency How Big Does Π Have to Be? Happy Accidents Direct

23. 23 Consumers Care About Supply of a Complementary Good Platforms & Applications Operating Systems and Software Consoles and Games DVDs and Movies Indirect

24. 24 More Platforms More Applications More Consumers More Platforms Indirect

25. 25 Indirect Closed Standards Exclusive Licenses Games Open Standards Reducing The Platform’s Power Should We Protect Interfaces? Happy Accidents Interoperability

26. 26 Physical Natural Monopolies Hydroelectic Dams Marginal Cost Competitions Congestion

27. 27 Physical Networks Internet, Telephones Competition Congestion Opening The Network The Last Mile Physical

28. 28 Stephen M. Maurer Goldman School of Public Policy IT and Public Policy – Oct. 21, 2004