Industrial Organization or Imperfect Competition Overview and Network externalities

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Industrial Organization or Imperfect
Competition Overview and Network externalities

• Univ. Prof. dr. Maarten Janssen
• University of Vienna
• Summer semester 2008
• Week 14 (June 23)

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Network externalities

• Externality
• Action taken by one agent directly affects
  utility of other agent
• Network externailty
• Take up of commodity by one, positively affects
  utility of others
• Direct you positively value the size of the
  network (e.g., telephony)
• Indirect you value services and the level of
  services depends on network (e.g. while buying a
  car)
• Main question how does the presence of network
  effects affects market competition and innovation

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Simple Model

• Consumer values network and product
• V r am, where m is size of network, r is
  value of product itself
• Old and new product (records and cds, etc.)
• Vi ri ami I o,n
• With ro lt rn
• Installed base of old technology mo free people
  m
• New technology has only a chance to be introduced
  if rn - ro a(mo m)
• Either installed base should not be large
• Or network effect should not be too important

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Multiple equilibria possible

• If people expect old technology to remain
  leading, then no one will adopt new technology if
  ro a(mo m) gt rn
• If people expect new technology to dominate, then
  new users will choose new if rn - ro a(mo m)
• Both inequalities can hold simultaneously
• Expectations are important
• Social value of innovation and individual
  incentives do not need to be alligned.

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Overview of course

• No strategic interaction
• Monopoly and perfect competition
• Strategic interaction
• Oligopoly and game theory
• Common methodology
• Rational behavior players
• Equilibrium situations
• Simple models to make a point
• Environment differs each time

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Monopoly

• Standard pricing
• Mark-up rule, depending on elasticity of demand
• Price discrimination
• 1st, 2nd, 3rd degree
• 2nd degree screening (menu of contracts)
• Intertemporal price setting
• If you sell durable good and consumers can also
  buy tomorrow, they may expect you to set lower
  prices tomorrow and postpone their purchase
• Vertical relations, double marginalization
• Franchise fees

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Oligopoly

• Basic models are cornerstones
• Bertrand
• Cournot
• Stackelberg

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Bertrand as cornerstone

• Product differentiation
• Horizontal, vertical
• Capacity constraints
• When is Cournot model more reasonable, despite
  firms setting prices?
• Consumer search
• Invest resources to get information about price,
  quality
• Price dispersion, mixed strategies
• Firms setting different prices not necessarily
  outcome of selling different products
• Entry deterrence limit pricing

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Cournot, Stackelberg as cornerstone

• Entry deterrence in terms of excess capacity
• Collusion in OPEC

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Miscellaneous topics

• Mergers
• Network externalities
• Auctions (possible, not discussed)