nep-mic New Economics Papers
on Microeconomics
Issue of 2006‒08‒26
seventeen papers chosen by
Joao Carlos Correia Leitao
Universidade da Beira Interior

  1. Pricing of Complementary Goods and Network Effects* By Nicholas Economides; V. Brian Viard
  2. The Economics of the Internet Backbone By Nicholas Economides
  3. The Incentive for Vertical Integration By Nicholas Economides
  5. Two-sided competition of proprietary vs. open source technology platforms and the implications for the software industry1 By Nicholas Economides; Evangelos Katsamakas
  6. Price Peer-to-Peer Networks: A Mechanism Design Approach By Oksana Loginova; X. Henry Wang; Haibin Lu
  7. Quantifying the Benefits of Entry into Local Phone Service, By Nicholas Economides; V. Brian Viard; Katja Seim
  8. Effects of Industry Concentration on Quality Choices for Network Connectivity By Mark A. Jamison;
  9. Strategic Product Pre-announcements in Markets with Network Effects By Jay Pil Choi; Eirik Gaard Kristiansen; Jae Nahm
  10. Patents, Price Controls and Access to New Drugs: How Policy Affects Global Market Entry By Jean O. Lanjouw
  11. Informative Voting and the Samuelson Rule By Felix Bierbrauer; Marco Sahm
  13. Digital Rights Management and the Pricing of Digital Products By Yooki Park; Suzanne Scotchmer
  14. Resource Allocation and Firm Scope By Guido Friebel; Michael Raith
  15. Congestion Pricing in an Internet Market By Jose Canals-Cerda
  16. Risk Attitudes and Internet Search Engines: Theory and Experimental Evidence By Aurora García-Gallego; Nikolaos Georgantzís; Pedro Pereira; José C. Pernías-Cerrillo
  17. Hicksian Surplus Measures of Individual Welfare Change When There is Price and Income Uncertainty By Weymark, John A.; Blackorby, Charles; Donaldson, David

  1. By: Nicholas Economides (Stern School of Business, New York University); V. Brian Viard (Graduate School of Business, Stanford University)
    Abstract: We discuss the case of a monopolist of a base good in the presence of a complementary good provided either by it or by another firm. We assess and calibrate the extent of the influence on the profits from the base good that is created by the existence of the complementary good, i.e., the extent of the network effect. We establish an equivalence between a model of a base and a complementary good and a reduced-form model of the base good in which network effects are assumed in the consumers’ utility functions as a surrogate for the presence of direct or indirect network effects, such as complementary goods produced by other firms. We also assess and calibrate the influence on profits of the intensity of network effects and quality improvements in both goods. We evaluate the incentive that a monopolist of the base good has to improve its quality rather than that of the complementary good under different market structures. Finally, based on our results, we discuss a possible explanation of the fact that Microsoft Office has a significantly higher price than Microsoft Windows although both products have comparable market shares.
    Keywords: calibration; monopoly; network effects; complementary goods; software; Microsoft
    JEL: L12 L13 C63 D42 D43
    Date: 2005–11
  2. By: Nicholas Economides (Stern School of Business, NYU)
    Abstract: This paper discusses the economics of the Internet backbone. I discuss competition on the Internet backbone as well as relevant competition policy issues. In particular, I show how public protocols, ease of entry, very fast network expansion, connections by the same Internet Service Provider (“ISP”) to multiple backbones (ISP multi-homing), and connections by the same large web site to multiple ISPs (customer multi-homing) enhance price competition and make it very unlikely that any firm providing Internet backbone connectivity would find it profitable to degrade or sever interconnection with other backbones in an attempt to monopolize the Internet backbone.
    Keywords: Internet, network effects, Internet backbone, competition, monopoly, MCI, WorldCom
    JEL: L12 L13 C63 D42 D43
    Date: 2004–10
  3. By: Nicholas Economides (Stern School of Business, NYU)
    Abstract: This paper evaluates the incentive of firms to vertically integrate in a simple 2X2 Bertrand model of two substitutes that are each comprised of two complementary components. It confirms that all prices fall as a result of a vertical merger. Further, we find that, when the composite goods are poor substitutes, producers of complementary components are better off after integration. Thus, at equilibrium, each pair of complementary goods is produced by a single firm (parallel vertical integration). In contrast, when the composite goods are close substitutes, vertical integration reduces profits of the merging firms and is therefore undesirable. Thus, at equilibrium, all four products are produced by independent firms (independent ownership). The reason for the change in the direction of the incentive to merge is that, as the composite goods become closer substitutes, competition between them reduces prices (in comparison to full monopoly) thereby eliminating the usefulness of a vertical merger in accomplishing the same price effect. We also find that, for intermediate levels of substitution, firms producing complementary components prefer to merge only if the substitute good is produced by an integrated firm. Thus, for intermediate levels of substitution, both parallel vertical integration and independent ownership are equilibria. When the demand system is symmetric, total surplus is higher in parallel vertical integration, for all degrees of substitution among the products, even for the case when the goods are close substitutes and parallel vertical integration is not the equilibrium outcome. Thus, the market provides less vertical integration than is optimal from a social surplus maximizing point of view.
    Keywords: Mergers, vertical integration
    JEL: L1 D4
    Date: 2005–01
  4. By: Katja Seim (Graduate School of Business, Stanford University); V. Brian Viard (Graduate School of Business, Stanford University)
    Abstract: We test the effect of entry on the tariff choices of incumbent cellular firms. We relate the change in the breadth of calling plans between 1996, when incumbents enjoyed a duopoly market, and 1998, when incumbents faced increased competition from personal communications services (PCS) firms. Entry by PCS competitors differed across geographic markets due to the number of licenses left undeveloped as a result of the bankruptcy of some of the auctions’ winning bidders and due to variation across markets in the time required to build a sufficiently large network of wireless infrastructure. We find that incumbents increase tariff variety in markets with more entrants and that this effect is not explained by demographic heterogeneity or cost differences in maintaining calling plans across markets. We also find that incumbents are more likely to upgrade their technology from the old analog technology to the new digital technology in markets with more entry, suggesting that entry also has indirect effects on tariff choice via firms’ technology adoption decisions.
    Keywords: entry, market structure, cellular, price discrimination, nonlinear pricing, telecommunications
    JEL: L11 L13 L25 L96
    Date: 2004–11
  5. By: Nicholas Economides (Stern School of Business, NYU); Evangelos Katsamakas (Fordham University)
    Abstract: Technology platforms, such as Microsoft Windows, are the hubs of technology industries. We develop a framework to characterize the optimal two-sided pricing strategy of a platform firm, that is, the pricing strategy towards the direct users of the platform as well as towards firms offering applications that are complementary to the platform. We compare industry structures based on a proprietary platform (such as Windows) with those based on an open-source platform (such as Linux) and analyze the structure of competition and industry implications in terms of pricing, sales, profitability, and social welfare. We find that, when the platform is proprietary, the equilibrium prices for the platform, the applications, and the platform access fee for applications may be below marginal cost, and we characterize demand conditions that lead to this. The proprietary applications sector of an industry based on an open source platform may be more profitable than the total profits of a proprietary platform industry. When users have a strong preference for application variety, the total profits of the proprietary industry are larger than the total profits of an industry based on an open source platform. The variety of applications is larger when the platform is open source. When a system based on an open source platform with an independent proprietary application competes with a proprietary system, the proprietary system is likely to dominate the open source platform industry both in terms of marketshare and profitability. This may explain the dominance of Microsoft in the market for PC operating systems.
    Date: 2005–10
  6. By: Oksana Loginova (Department of Economics, University of Missouri-Columbia); X. Henry Wang (Department of Economics, University of Missouri-Columbia); Haibin Lu
    Abstract: AIn this paper we use mechanism design approach to find the optimal file-sharing mechanism in a peer-to-peer network. This mechanism improves upon existing incentive schemes. In particular, we show that peer-approved scheme is never optimal and service-quality scheme is optimal only under certain circumstances. Moreover, we find that the optimal mechanism can be implemented by a mixture of peer-approved and service-quality schemes.
    Keywords: peer-to-peer networks, mechanism design.
    JEL: D82 C7
    Date: 2006–07–19
  7. By: Nicholas Economides (Stern School of Business, NYU); V. Brian Viard (Graduate School of Business, Stanford University); Katja Seim (Stanford University)
    Abstract: See #46
    JEL: D43 K23 L11 L13 L96
    Date: 2005–11
  8. By: Mark A. Jamison (University of Florida);
    Abstract: I examine the effects of market concentration on connectivity in network industries. Using Cournot interactions for a duopoly, each network chooses quantity, quality for communications within the provider’s own network (internal quality), and quality for communications between the provider’s network and other networks (external quality). I find that large networks choose higher internal quality than do small networks and large networks choose higher internal quality than external quality. I also find that providers prefer flexible technologies that allow them to simultaneously choose outputs and qualities. Small networks prefer higher external quality than internal quality except when they make credible quality commitments before choosing output and have higher marginal operating costs than large networks. Networks choose identical external quality unless they have exogenously determined customer bases.
    Date: 2004–10
  9. By: Jay Pil Choi (Michigan State University); Eirik Gaard Kristiansen (Michigan State University); Jae Nahm (HKUST, Hong Kong)
    Abstract: It is a widely adopted practice for firms to announce new products well in advance of actual market availability. The incentives for pre-announcements are stronger in markets with network effects because they can be used to induce the delay of consumers’ purchases and forestall the build-up of rival products’ installed bases. However, such announcements often are not fulfilled, raising antitrust concerns. We analyze the effects of product pre-announcements in the presence of network effects when firms are allowed to strategically make false announcements. We also discuss their implications for consumer welfare and anti-trust policy.
    JEL: L1 D8
    Date: 2005–09
  10. By: Jean O. Lanjouw
    Abstract: We consider how patent rights and price regulation affect whether new drugs are marketed in a country, and how quickly. The analysis covers a large sample of 68 countries at all income levels and includes all drug launches over the period 1982-2002. It uses newly compiled information on legal and regulatory policy, and is the first systematic analysis of the determinants of drug launch in poor countries. Price control tends to discourage rapid product entry, while the results for patents are mixed. There is evidence that local capacity to innovate matters and that international pricing externalities may play a role.
    Keywords: patent, drugs, access, market entry, price control
    JEL: D62 D4 K2 K10 I11 I18
  11. By: Felix Bierbrauer (Max Planck Institute for Research on Collective Goods, Kurt-Schumacher-Str. 10, 53113 Bonn, Germany.; Marco Sahm (Lehrstuhl für Finanzwissenschaft, Ludwigstrasse 28 Vgb. III, 80539 München, Germany.
    Abstract: We study the classical free-rider problem in public goods provision in a large economy with uncertainty about the average valuation of the public good. Individual preferences over public goods are shaped by a skill and a taste parameter. We use a mechanism design approach to solve for the optimal utilitarian provision rule. The relevant incentive constraints for information aggregation ensure that individuals behave as if they were engaging in informative voting over the level of public good provision. It is shown that the use of information by an optimal provision rule is inversely related to the polarization of preferences which results from the properties of the skill distribution.
    Keywords: information aggregation, informative voting, public goods, two-dimensional heterogeneity
    JEL: H41 D71 D72 D82
    Date: 2006–07
  12. By: Nicholas Economides (Stern School of Business, NYU)
    Abstract: Trinko, a local telecommunications services customer of AT&T, sued Verizon for anti-competitively raising the costs of AT&T, Verizon's rival in the market for local telecommunications services. Pursuant to the rules of the Telecommunications Act of 1996, AT&T was leasing parts of the local telecommunications network (unbundled network elements, "UNEs") from Verizon at "cost plus reasonable profit" prices. The Supreme Court held that Trinko's complaint failed to state a claim under § 2 of the Sherman Act, and dismissed the complaint. I argue that the Court drew in- .correct inferences from its AsPen Skiing decision. The Court also missed a key vertical leveraging issue in Trinko. The opening of competition mandated by the Telecommunications Act of 1996 challenged Verizon's traditional monopoly in the local telecommunications services market. By raising the cost and/or decreasing the quality of the service of rivals in the retailing services market, Verizon aimed to preserve that monopoly. As a result of these efforts, rivals suffered a disadvantage. Yet Verizon also caused retailing rivals to lease a lower number of unbundled network elements and thus incurred a revenue sacrifice. Therefore the actions ofVerizon in raising the costs of retailing telecommunications services rivals are an indication of. liability according to the. "sacrifice principle" proposed in the Government's brief in Trinko, according to which a defendant is liable if its conduct "involves a sacrifice of short-term profits or goodwill that makes sense only insofar as it helps the defendant maintain or obtain monopoly power," even though the sacrifice principle defines a stringent condition for a finding of liability.
    Date: 2005–11
  13. By: Yooki Park (University of California, Berkeley); Suzanne Scotchmer (University of California, Berkeley)
    Abstract: Digital products such as movies, music and computer software are protected both by self-help measures such as encryption and copy controls, and by the legal right to prevent copying. We explore how digital rights management and other technical protections a®ect the pricing of content, and consequently, why content users, content vendors, and antitrust authorities might have di®erent views on what technical capabilities should be deployed. We discuss the potential for \collusion through technology."
    Keywords: technical protections, DRM, antitrust, trusted systems
    JEL: L13 L14 L15 K21 O33
    Date: 2004–09–30
  14. By: Guido Friebel (University of Toulouse (EHESS and IDEI), CEPR and IZA Bonn); Michael Raith (University of Rochester and University of Southern California)
    Abstract: We develop a theory of firm scope in which integrating two firms into one facilitates the allocation of resources, but leads to weaker incentives for effort, compared with nonintegration. Our theory makes minimal assumptions about the underlying agency problem. Moreover, the benefits and costs of integration originate from the same problem – to allocate resources efficiently, the integrated firm's top management must obtain information about the possible use of resources from division managers. The division managers' job is to create profitable investment projects. Giving the managers incentives to do so biases them endogenously towards their own divisions, and gives them a motive to overstate the quality of their projects in order to receive more resources. We show that paying managers based on firm performance in addition to individual performance can establish truthful upward communication, but creates a free-rider problem and raises the cost of inducing effort. This effect exists even though with perfect information, centralized resource allocation would improve the managers' incentives. The resulting tradeoff between a better use of resources and diminished incentives for effort determines whether integration or non-integration is optimal. Our theory thus provides a simple answer to Williamson's “selective-intervention” puzzle concerning the limits of firm size and scope. In addition, we provide an incentivebased argument for the prevalence of hierarchically structured firms in which higher-level managers coordinate the actions of lower-level managers.
    Keywords: theory of the firm, coordination, authority, incentives, strategic information transmission
    JEL: D23 D82 L22 M52
    Date: 2006–08
  15. By: Jose Canals-Cerda (University of Colorado at Boulder)
    Abstract: This paper analyzes a unique dataset of art auctions on eBay. We study the behavior of buyers and sellers, demand and supply, by means of a novel structural estimation approach. Our empirical framework considers the process of arrival of new bidders as well as the distribution of bidder valuations of artworks being auctioned. We use this empirical framework to quantify the e(ect of market congestion, and congestion pricing strategies implemented by the market intermediary. Because we explicitly model the process of arrival of new bidders, we can estimate the e(ect of congestion pricing on the number of bidders, the distribution of bidders’ valuations, and the final selling price. Using the structural model we can also measure the impact of congestion pricing on the revenues of the artists and the market intermediary, as well as its e(ect on consumer surplus. Our results indicate that the congestion pricing policy acts as a coordination mechanism that facilitates the match between buyers and sellers.
    JEL: C51 C72 D44 L11 L14
    Date: 2005–09
  16. By: Aurora García-Gallego (Universitat Jaume I (Castellón, Spain)); Nikolaos Georgantzís (Universitat Jaume I (Castellón, Spain)); Pedro Pereira (Autoridade da Concorrência (Portugal)); José C. Pernías-Cerrillo (Universitat Jaume I (Castellón, Spain))
    Abstract: This paper analyzes the impact on consumer prices of the size and biases of price comparison search engines. We develop several theoretical predictions, in the context of a model related to Burdett and Judd (1983) and Varian (1980), and test them experimentally. The data supports the model’s predictions regarding the impact of the number of firms, and the type of bias of the search engine. The data does not support the model’s predictions regarding the impact of the size of the search engine. We identified several data patterns, and developed an econometric model for the price distributions. Variables accounting for risk attitudes improved significantly the explanatory power of the econometric model.
    Keywords: Search engines, incomplete information, biased information, price levels, experiments
    JEL: D43 D83 L13
    Date: 2004–10
  17. By: Weymark, John A.; Blackorby, Charles; Donaldson, David
    Abstract: This article considers measures of individual welfare change for projects that change the state distribution of prices and incomes. For a consumer whose preferences satisfy the expected utility hypothesis, we investigate whether there is an increasing function of the state-contingent compensating variations that is positive valued if and only if a project makes the consumer better off ex ante when income and some or all prices are permitted to vary across states. We show that any such measure of individual welfare change must rank projects by their expected compensating variation. Furthermore, the indirect utility function that the consumer uses to evaluate prices and income in each state and that is used to compute expected utilities must be affine in income with the origin term independent of all prices and the weight on income independent of those prices that are uncertain. These restrictions imply that perferences are homothetic. If all prices are uncertain, these conditions are inconsistent with the homogeneity properties of an indirect utility function and, hence we obtain an impossibility result.
    JEL: D61 D81
    Date: 2006–08–09

This nep-mic issue is ©2006 by Joao Carlos Correia Leitao. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.