16
CHAPTER
DYNAMIC P OWERP 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
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questions
Food for Thought….
Some good blogs and other sites to get the juices flowing:
Network Goods
A Network 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 Equilibrium is a situation in which no
player has an incentive to change their
Tyler
strategy unilaterally.
Alex
Apple
Microsoft
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.
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Standard Wars are Common
Sony
Toshiba
HD-DVD
Blu-Ray
HD-DVD
(10, 8)
(0, 0)
Blu-Ray
(0, 0)
(8,10)
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
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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 Duopoly
P
Q
$0
140
5
130
10
120
15
110
20
100
 Smalltown’s demand schedule
25
90
 Two firms: T-Mobile, Verizon
30
80
35
70
40
60
45
50
 Smalltown has 140 residents
 The “good”:
cell phone service with unlimited anytime
minutes and free phone
(duopoly: an oligopoly with two firms)
 Each firm’s costs: FC = $0, MC = $10
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Nash Equilibrium
P
Q
$0
140
5
Revenue
Cost
Profit
$0
$1,400
–1,400
130
650
1,300
–650
10
120
1,200
1,200
0
15
110
1,650
1,100
550
20
100
2,000
1,000
1,000
25
90
2,250
900
1,350
30
80
2,400
800
1,600
35
70
2,450
700
1,750
40
60
2,400
600
1,800
45
50
2,250
500
1,750
Competitive
outcome:
P = MC = $10
Q = 120
Profit = $0
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 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
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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 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
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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
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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
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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
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e) $19.99
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-toreplicate resource.
4. Consumers are open to the prospect of
dealing with a new competitor.
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SEE THE INVISIBLE HAND
City water: less contestable
Mineral water: more contestable
Limiting Contestability with
Switching Costs
http://awkwardfamilyphotos.com/
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)
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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?
B
A CK
T O
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Music can be considered a network good in the sense
that
a)
b)
c)
d)
many people today listen to music online and
over computer networks.
the preferences of individual consumers are
independent of what others like.
music is produced by large networks of bands,
record labels, and music stores.
many consumers prefer to purchase music that
others purchase as well.
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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.
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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
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In a “standard war:”
a)
b)
c)
d)
there are two good equilibria, but the
players differ over which equilibrium is the
best.
there is only one good equilibrium, but
players get locked into the “bad”
equilibrium.
the Nash equilibrium never dominates.
both players would prefer to have no
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standard.
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All cartels and cartel-like behavior
are illegal in the United States
a) True
b) False
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