1Stephen M. MaurerGoldman School of Public Policy

IT and Public Policy – Oct. 21, 2004

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Motivating Examples:TCP/IP & Berkeley UnixGSMThe WebThe Browser Wars

etc., etc., etc…

Introduction

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Old Economy ExternalitiesPollution (Negative)Flower Gardens (Positive)

Network Externalities“I Care If You Use It”How Big Should the Network Be?

Lawyers & WordPerfect . . .

Introduction

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1. Direct Network ExternalitiesMS Word

2. Indirect Network ExternalitiesOperating Systems & Games

3. Physical Network ExternalitiesInternet & Telephones

Introduction

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W (p)

Pric

e

Users

Old Economy

Direct

S(p)

D = w(p)

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W (p)

Pric

e

Users

Old Economy

DirectW’ (p)

S(p)

Shifting Demand

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New Economy “I Care if You Use It”D = w(p, n)Multiple Demand CurvesImplications for Efficiency

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Users

Demand

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Users

CompetitionNotes: • Self-Consistency • Multiple Equilibria

P = MC

n1 n2 n3

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Usersn1 n2 n3

Monopoly

MC

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Usersn1 n2 n3

Monopoly

MC

Direct

12

W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Usersn1 n2 n3

Monopoly

MC

Direct

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Tactics

User NetworksPenetration PricingConsumers Expectations

HypeVaporwareAttack Ads

Direct

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TacticsCommitment Strategies

Second SourcesIntel, IBM PC

Renouncing MonopolyNetscape Navigator

Investments & AlliancesThe PC

Reputation

Direct

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Tipping

Direct

Network EffectsThe Best Product Doesn’t Always Win!

VHS vs. Beta

R&D EffectsAppropriabilityIncreased Demand

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Tipping

Direct

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Efficiency

Static EfficiencyThe Old Economy AnswerHow Big Should The Network Be?Which Institution Comes Closest?

Dynamic EfficiencyLock-In vs. Stranding

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Usersn1 n2 n3

Efficiency

MC

Direct

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W (p, n1)

W (p,n2)

W (p,n3)

Pric

e

Usersn1 n2 n3

Efficiency

MC

Direct

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EfficiencyMonopoly vs. Competition

Network ExternalitiesPrice & DWLVarietyEconomies of Scale & Duplicated R&D

Is The Competitive Solution Ideal?

Direct

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Efficiency

Stranding vs. Lock-InSwitching Costs Coordination ProblemsAggressive PricingBeta vs. Leaded Gasoline

Direct

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Efficiency

Open Standards“Look and Feel”

Ex Ante vs. Ex Post EfficiencyHow Big Does Π Have to Be?Happy Accidents

Direct

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Consumers Care AboutSupply of a Complementary GoodPlatforms & Applications

Operating Systems and SoftwareConsoles and GamesDVDs and Movies

Indirect

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MorePlatforms

MoreApplications

More Consumers

MorePlatforms

Indirect

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Indirect

Closed StandardsExclusive Licenses

• Games

Open StandardsReducing The Platform’s Power

Should We Protect Interfaces?Happy Accidents

Interoperability

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Physical

Natural MonopoliesHydroelectic DamsMarginal CostCompetitionsCongestion

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Physical NetworksInternet, TelephonesCompetitionCongestion

Opening The NetworkThe Last Mile

Physical

28Stephen M. MaurerGoldman School of Public Policy

IT and Public Policy – Oct. 21, 2004