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Chapter Thirty-Four Information Technology. Information Technologies u Computers, answering machines, FAXes, pagers, cellular phones, … u Many provide.

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Presentation on theme: "Chapter Thirty-Four Information Technology. Information Technologies u Computers, answering machines, FAXes, pagers, cellular phones, … u Many provide."— Presentation transcript:

1 Chapter Thirty-Four Information Technology

2 Information Technologies u Computers, answering machines, FAXes, pagers, cellular phones, … u Many provide strong complementarities. u E.g. email is useful only if lots of people use it -- a network externality. u And computers are more useful if many people use the same software.

3 Information Technologies u But then switching technologies becomes very costly -- lock-in. u E.g. Microsoft Windows. u How do markets operate when there are switching costs or network externalities?

4 Competition & Switching Costs u Producers cost per month of providing a network service is c per customer. u Customers switching cost is s. u Producer offers a one month discount, d. u Rate of interest is r.

5 Competition & Switching Costs u All producers set the same nondiscounted price of p per month. u When is switching producers rational for a customer?

6 Competition & Switching Costs u Cost of not switching is

7 Competition & Switching Costs u Cost of not switching is u Cost from switching is

8 Competition & Switching Costs u Cost of not switching is u Cost from switching is u Switch if

9 Competition & Switching Costs u Cost of not switching is u Cost from switching is u Switch if u I.e. if

10 Competition & Switching Costs u Switch if u I.e. if u Producer competition will ensure at a market equilibrium that customers are indifferent between switching or not

11 Competition & Switching Costs u At equilibrium, producer economic profits are zero. u I.e.

12 Competition & Switching Costs u At equilibrium, producer economic profits are zero. u I.e. u Since, at equilibrium

13 Competition & Switching Costs u At equilibrium, producer economic profits are zero. u I.e. u Since, at equilibrium u I.e. present-valued producer profit = consumer switching cost.

14 Competition & Network Externalities u Individuals 1,…,1000. u Each can buy one unit of a good providing a network externality. u Person v values a unit of the good at nv, where n is the number of persons who buy the good.

15 Competition & Network Externalities u Individuals 1,…,1000. u Each can buy one unit of a good providing a network externality. u Person v values a unit of the good at nv, where n is the number of persons who buy the good. u At a price p, what is the quantity demanded of the good?

16 Competition & Network Externalities u If v is the marginal buyer, valuing the good at nv = p, then all buyers v > v value the good more, and so buy it. u Quantity demanded is n = 1000 - v. u So inverse demand is p = n(1000-n).

17 Competition & Network Externalities 01000 n Willingness-to-pay p = n(1000-n) Demand Curve

18 Competition & Network Externalities u Suppose all suppliers have the same marginal production cost, c.

19 Competition & Network Externalities 01000 n Demand Curve Supply Curve c Willingness-to-pay p = n(1000-n)

20 Competition & Network Externalities u What are the market equilibria?

21 Competition & Network Externalities u What are the market equilibria? u (a) No buyer buys, no seller supplies. –If n = 0, then value nv = 0 for all buyers v, so no buyer buys. –If no buyer buys, then no seller supplies.

22 Competition & Network Externalities 01000 n Demand Curve Supply Curve (a) c Willingness-to-pay p = n(1000-n)

23 Competition & Network Externalities 01000 n Demand Curve Supply Curve n (a) c Willingness-to-pay p = n(1000-n)

24 Competition & Network Externalities u What are the market equilibria? u (b) A small number, n, of buyers buy. –small n small network externality value nv –good is bought only by buyers with nv c; i.e. only large v v = c/n.

25 Competition & Network Externalities 01000 n Demand Curve Supply Curve n (b) n (c) (a) c Willingness-to-pay p = n(1000-n)

26 Competition & Network Externalities u What are the market equilibria? u (c) A large number, n, of buyers buy. –Large n large network externality value nv –good is bought only by buyers with nv c; i.e. up to small v v = c/n.

27 Competition & Network Externalities 01000 n Demand Curve Supply Curve n (b) n (c) (a) c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n)

28 Competition & Network Externalities u Suppose the market expands whenever willingness-to-pay exceeds marginal production cost, c.

29 Competition & Network Externalities 01000 n Demand Curve Supply Curve nn c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n)

30 Competition & Network Externalities 01000 n Demand Curve Supply Curve nn c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n) Unstable

31 Competition & Network Externalities 01000 n Demand Curve Supply Curve n c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n)

32 Competition & Network Externalities 01000 n Demand Curve Supply Curve n c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n) Stable

33 Competition & Network Externalities 01000 n Demand Curve Supply Curve n c Which equilibrium is likely to occur? Willingness-to-pay p = n(1000-n) Stable

34 Rights Management u Should a good be v sold outright, v licensed for production by others, or v rented? u How is the ownership right of the good to be managed?

35 Rights Management u Suppose production costs are negligible. u Market demand is p(y). u The firm wishes to

36 Rights Management

37

38

39 u The rights owner now allows a free trial period. This causes –an increase in consumption

40 Rights Management u The rights owner now allows a free trial period. This causes –an increase in consumption and a decrease in sales per unit of consumption

41 Rights Management u The rights owner now allows a free trial period. This causes –increase in value to all users increase in willingness-to-pay;

42 Rights Management

43 u The firms problem is now to

44 Rights Management u The firms problem is now to u This problem must have the same solution as

45 Rights Management u The firms problem is now to u This problem must have the same solution as u So

46 Rights Management

47 higher profit

48 Rights Management lower profit

49 Sharing Intellectual Property u Produce a lot for direct sales, or only a little for multiple rentals? u Lending books, software. u Renting tools, videos etc. u Sell movies directly, or only sell to video rental stores, or pay-per-view? u When is selling for rental more profitable than selling for personal use only?

50 Sharing Intellectual Property u F is the fixed cost of designing the good. u c is the constant marginal cost of copying the good. u p(y) is the market demand. u Direct sales problem is to

51 Sharing Intellectual Property u F is the fixed cost of designing the good. u c is the constant marginal cost of copying the good. u p(y) is the market demand. u Direct sales problem is to

52 Sharing Intellectual Property u Is selling for rental more profitable? u Each rental unit is used by k > 1 consumers. u So y units sold x = ky consumption units.

53 Sharing Intellectual Property u Is selling for rental more profitable? u Each rental unit is used by k > 1 consumers. u So y units sold x = ky consumption units. u Marginal consumers willingness-to- pay is p(x) = p(ky).

54 Sharing Intellectual Property u Is selling for rental more profitable? u Each rental unit used by k > 1 consumers. u So y units sold x = ky consumption units. u Marginal consumers willingness-to- pay is p(x) = p(ky). u Rental transaction cost t reduces willingness-to-pay to p(ky) - t.

55 Sharing Intellectual Property u Rental transaction cost t reduces willingness-to-pay to p(ky) - t. u Rental stores willingness-to-pay is

56 Sharing Intellectual Property u Rental transaction cost t reduces willingness-to-pay to p(ky) - t. u Rental stores willingness-to-pay is u Producers sale-for-rental problem is

57 Sharing Intellectual Property u Rental transaction cost t reduces willingness-to-pay to p(ky) - t. u Rental stores willingness-to-pay is u Producers sale-for-rental problem is

58 Sharing Intellectual Property u Rental transaction cost t reduces willingness-to-pay to p(ky) - t. u Rental stores willingness-to-pay is u Producers sale-for-rental problem is

59 Sharing Intellectual Property is the same problem as the direct sale problem except for the marginal costs.

60 Sharing Intellectual Property is the same problem as the direct sale problem except for the marginal costs. Direct sale is better for the producer if

61 Sharing Intellectual Property u Direct sale is better for the producer if u I.e. if

62 Sharing Intellectual Property u Direct sale is better for the producer if u Direct sale is better if –replication cost c is low –rental transaction cost t is high –rentals per item, k, is small.


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