Third Edition Competing for Monopoly: The Economics of Network Goods Chapter 16

Third Edition

Competing for Monopoly: The Economics of Network Goods

Chapter 16

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. Answer: b

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.

Answer: a

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.

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

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).

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).

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.

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”.

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

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.

Answer: c

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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Self-Check

Which of the following is most likely to operate in a contestable market?

a. Railroad.

b. Pharmaceutical company.

c. Restaurant.

Answer: c

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

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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