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. 2

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. 3

Definition Network good: a good whose value to one consumer increases the more other consumers use the good. 4

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. 5 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”. 6

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 7

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 8

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. 9 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 10

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. 11

Coordination Game 12 Tyler AppleMicrosoft Alex Apple (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 13 Tyler AppleMicrosoft Alex Apple (11, 11)(3, 3) Microsoft (3, 3)(10, 10) Tyler’s payoff

Coordination Game 14 Tyler AppleMicrosoft Alex Apple (11, 11)(3, 3) Microsoft (3, 3)(10, 10) If they use different software, it is difficult to work together (low payoffs).

Coordination Game 15 Tyler AppleMicrosoft Alex Apple (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 16 Tyler AppleMicrosoft Alex Apple (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. 17

Coordination Game 18 Tyler AppleMicrosoft Alex Apple (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 19  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 20

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. 21 Answer: c

Markets for Network Goods 3. Competition “for the market”  Consumer loyalties can switch quickly  A monopoly can easily change hands  1988: Lotus had 70% of the spreadsheet market  1998: Excel had 70% of the market  Results in serial monopolies 22

Definition Contestable Market: A market in which the threat of potential competition is enough to make it behave competitively. 23

Self-Check Which of the following is most likely to operate in a contestable market? a.Railroad. b.Pharmaceutical company. c.Restaurant. 24 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 25

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 26

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 27

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 28

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 29