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Economics 153 Economics of the Internet Ward Hanson Greg Rosston T.A.: Lori Parcel

Economics 153 Today Goals for the course Syllabus Microeconomic review Thursday Internet Infrastructure – Readings in syllabus

Microeconomic Review Demand Curves Q d =  0 –  1 *P (Simple linear case) P Q D

Demand Curves P Q D D'D' D"D"

P Q D D'D'

Elasticity Own-price elasticity Inelastic  d > -1 (between zero and -1) Elastic  d < -1 Firm vs. Market

Elasticity Cross-price elasticity Substitutes  01 < 0 Complements  01 > 0 Where does firm produce?

Review Exercises Show the elastic and inelastic portions of linear demand curve Graphically and mathematically show In what portion of demand curve firm will operate. Why other portions don’t maximize profit.

Marginal Revenue (A<0 for a normal good)

Marginal Revenue (con’t)

Marginal Revenue Curve P Q D MR

Cost Functions

Cost Curves $ Q TC F AC MC

Scale and Scope Economies of scale TC(2A) < 2*TC(A) Economies of scope TC(A,B) < [TC(A) + TC(B)]

Competition Assumptions necessary What happens when those are violated? What happens when costs change? What happens when demand changes?

Theory of Monopoly How does firm act differently? What is profit maximizing rule?

Monopoly P Q D MR AC MC QmQm PmPm

Monopoly? P Q D AC

Monopoly? P Q D AC

Double Marginalization vs. Selling Direct Internet leads many manufacturers (for example: Tivo, HP) to think about selling direct to consumers. Situation 1: Sell direct to consumers. Situation 2: Set wholesale price, with retail price set by a retailer.

Direct Sales: Monopoly again… P Q D MR MC QdQd PdPd Tivo bears all costs and gets all profit.

Manufacturer + retailer: One firm’s price is another’s cost P Q D MR QmQm PwPw MC r Tivo can’t control retail price, can’t capture as much profit, retail price is too high. Monopoly retailer (say, Best Buy) gets substantial profit. PrPr MC W MC d (scenario 1) (scenario 2)

Individual vs. Market Demand Previously considered market demand PQ D total demand Demand is a mixture of individual demands, some single unit and some multi-unit. Here, one person might buy 1 unit if price is high and 2 if price is lower.

Individual Demand Curve: Discrete A single customer’s demand (e.g. CDs). P Q D One individual’s demand Here demand is unit by unit, tracing out an individual demand curve. WTP 1 unit: WTP(1) WTP 2nd unit: WTP(2) – WTP(1) …

Individual Demand Curve: Continuous Again just a single individual, but a continuous range of quantity (e.g. gasoline) P Q D One individual’s demand

Multi-part Pricing What if a firm can charge both a price per unit p and a membership fee F ? Does it make more money? Why? Is it more efficient?

Consumer Surplus Area above market price, below demand. Q d =  0 –  1 *P (Simple linear case) P Q individual D How would we calculate that? Why would we calculate that? P max P market

Consumer Surplus Area above market price, below demand. Q d =  0 –  1 *P (Simple linear case) P Q individual D P max P market (only for linear demand)

Consumer Surplus Area above market price, below demand. P Q individual D P max P market

Price up, consumer surplus down. consumer surplus price

The perfect monopoly Charge EACH individual the marginal cost per unit, but a fee F equal to their surplus. P Q individual D P max P market MC Personal pricing, Rhapsody subscription

Game Theory (-5, -5)(-10, -1) (-1, -10)(-3, -3) Confess Don’t Confess Confess Don’t Player 1 Player 2

Internet Broadband Version (5, 5)(10, -5) (-5, 10)(3, 3) Current speedTriple speed Current Triple SBC’s DSL Comcast Cable Modem

Different market: Existing cable only (10, 0)(3, 4) (5, 0)(2, -2) No entryEnter high Current High High speed DSL Cable Modem