nep-net New Economics Papers
on Network Economics
Issue of 2006‒08‒26
fifteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Technical Compatibility and the Mode of Foreign Entry under Network Externalities By Mikhail Klimenko; Kamal Saggi
  2. Incompatibility, Product Attributes and Consumer Welfare: Evidence from ATMs By Christopher R. Knittel; Victor Stango
  3. Pricing of Complementary Goods and Network Effects* By Nicholas Economides; V. Brian Viard
  4. Indirect Network Effects and the Product Cycle: Video Games in the U.S., 1994-2002 By Matthew T. Clements; Hiroshi Ohashi
  5. How Do Incumbents Respond to the Threat of Entry? Evidence from the Major Airlines By Austan Goolsbee; Chad Syverson
  6. Price Peer-to-Peer Networks: A Mechanism Design Approach By Oksana Loginova; X. Henry Wang; Haibin Lu
  7. Incentives and Protocols for Self-Organizing Interest-Based Peer-to-Peer Networks By Michael D. Smith; Rahul Telang
  8. The Effect of P2P File Sharing on Music Markets: A Survival Analysis of Albums on Ranking Charts By Sudip Bhattacharjee; Ram D. Gopal; Kaveepan Lertwachara; James R. Marsden; Rahul Telang
  9. Effects of Industry Concentration on Quality Choices for Network Connectivity By Mark A. Jamison;
  10. The Economics of the Internet Backbone By Nicholas Economides
  11. Two-sided competition of proprietary vs. open source technology platforms and the implications for the software industry1 By Nicholas Economides; Evangelos Katsamakas
  12. Competing technologies in the database management systems market By Tobias Kretschmer
  14. The Economics of Open-Access Journals By Mark McCabe; Christopher Snyder

  1. By: Mikhail Klimenko (Georgia Institute of Technology); Kamal Saggi (Southern Methodist University)
    Abstract: This paper examines the preferences of a foreign firm and a welfare-maximizing host country government over two modes of foreign direct investment (FDI): de novo entry by the foreign firm and acquisition of the domestic incumbent. Two crucial features of the model are the presence of network externalities and (endogenously determined) partial incompatibility between the technology of the domestic incumbent and that introduced by the foreign firm. The relative impact of the modes of entry on local welfare is determined by the degree of competition (more intense under de novo entry) and the magnitude of the positive network externality (greater under acquisition). The clash between the foreign firm’s equilibrium choice and the local government’s ranking of the two modes of entry might be a potential motivation for policy restrictions that limit the degree of foreign ownership.
    Keywords: Foreign Direct Investment, Oligopoly, Acquisition, Network Externalities, Technology Transfer, Technical Compatibility
    JEL: F13 F23 O32
    Date: 2004–10
  2. By: Christopher R. Knittel (University of California, Davis); Victor Stango (Dartmouth College)
    Abstract: Incompatibility in markets with network effects can either benefit or harm consumers. Incompatibility reduces consumers’ ability to “mix and match” components offered by different sellers, but can also be associated with changes in product attributes that might benefit consumers. In this paper, we estimate the effects of incompatibility in a classic hardware/software market: ATM cards and machines. Our empirical model allows us to measure the indirect network effect relating the value of ATM cards to ATM availability. It also allows us to measure the effects of incompatibility as measured by ATM fees. Our sample contains a relatively discrete move toward incompatibility after 1996, when banks began to impose surcharges on non-customers using their ATM machines. We provide estimates of the partial equilibrium effects of increased incompatibility on consumer welfare, finding that ATM fees ceteris paribus reduce the indirect network effect associated with other banks’ ATMs. However, a surge in ATM deployment accompanies the shift to surcharging and in many cases completely offsets the reduction in welfare associated with higher fees. This suggests that welfare analyses should consider the interaction between incompatibility and changes in product attributes.
    Date: 2004–10
  3. 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
  4. By: Matthew T. Clements (University of Texas); Hiroshi Ohashi (University of Tokyo)
    Abstract: This paper examines the importance of indirect network effects in the U.S. video game market between 1994 and 2002. The diffusion of game systems is analyzed by the interaction between console adoption decisions and software supply decisions. Estimation results suggest that introductory pricing is an effective practice at the beginning of the product cycle, and expanding software variety becomes more effective later. The paper also finds a degree of inertia in the software market that does not exist in the hardware market. This observation implies that software providers continue to exploit the installed base of hardware users after hardware demand has slowed.
    Keywords: indirect network effects; penetration pricing; software variety
    JEL: C23 L68 M21
    Date: 2004–10
  5. By: Austan Goolsbee (University of Chicago); Chad Syverson (University of Chicago)
    Abstract: This paper examines how incumbents respond to the threat of entry of competitors, as distinguished from their response to competitors’ actual entry. It uses a case study from the passenger airline industry—specifically, the evolution of Southwest Airlines’ route network—to identify particular routes where the probability of future entry rises abruptly. When Southwest begins operating in airports on both sides of a route but not the route itself, this dramatically raises the chance they will start flying that route in the near future. We examine the pricing of the incumbents on threatened routes in the period surrounding such events. We find that incumbents cut fares significantly when threatened by Southwest’s entry into their routes. This is true even after controlling in several ways for airport-specific operating costs. The response of incumbents seems to be limited only to the threatened route itself, and not to routes out of nearby competitor airports where Southwest does not operate (e.g., fares drop on routes from Chicago Midway but not Chicago O’Hare). The largest responses appear to be restricted to routes that were concentrated beforehand. Incumbents do experience short-run increases in their passenger loads concurrent with these fare cuts. This is consistent with theories implying incumbents will try to generate some longer-term loyalty among current customers before the entry of a new competitor. We examine evidence relating this demand-building motive to frequent flyer programs and find suggestive evidence in favor of this notion. There is only weak evidence that incumbents increase capacity on the routes.
    Date: 2004–12
  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: Michael D. Smith (Carnegie Mellon University); Rahul Telang (Carnegie Mellon University)
    Abstract: Improving the information retrieval (IR) performance of peer-to-peer networks is an important and challenging problem. Recently, the computer science literature has attempted to address this problem by improving IR search algorithms. However, in peer-to-peer networks, IR performance is determined by both technology and user behavior, and very little attention has been paid in the literature to improving IR performance through incentives to change user behavior. We address this gap by combining the club goods economics literature and the IR literature to propose a next generation file sharing architecture. Using the popular Gnutella 0.6 architecture as context, we conceptualize a Gnutella ultrapeer and its local network of leaf nodes as a “club” (in economic terms). We specify an information retrieval-based utility model for a peer to determine which clubs to join, for a club to manage its membership, and for a club to determine to which other clubs they should connect. We simulate the performance of our model using a unique real-world dataset collected from the Gnutella 0.6 network. These simulations show that our club model accomplishes both performance goals. First, peers are self-organized into communities of interest — in our club model peers are 85% more likely to be able to obtain content from their local club than they are in the current Gnutella 0.6 architecture. Second, peers have increased incentives to share content — our model shows that peers who share can increase their recall performance by nearly five times over the performance offered to free-riders. We also show that the benefits provided by our club model outweigh the added protocol overhead imposed on the network for the most valuable peers.
    Date: 2004–10
  8. By: Sudip Bhattacharjee (School of Business, University of Connecticut); Ram D. Gopal (School of Business, University of Connecticut); Kaveepan Lertwachara (School of Business, University of Connecticut); James R. Marsden (School of Business, University of Connecticut); Rahul Telang (H John Heinz III School of Public Policy and Management, Carnegie Mellon University)
    Abstract: Recent technological and market forces have profoundly impacted the music industry. Emphasizing threats from peer-to-peer (P2P) technologies, the industry continues to seek sanctions against individuals who offer significant number of songs for others to copy. Yet there is little rigorous empirical analysis of the impacts of online sharing on the success of music products. Combining data on the performance of music albums on the Billboard charts with file sharing data from a popular network, we: 1) assess the impact of recent developments related to the music industry on survival of music albums on the charts, and 2) evaluate the specific impact of P2P sharing on an album’s survival on the charts. In the post P2P era, we find significantly reduced chart survival. The second phase of our study isolates the impact of file sharing on album survival. We find that sharing does not seem to hurt the survival of albums.
    Keywords: peer-to-peer, digitized music, online file sharing, survival.
    Date: 2005–10
  9. 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
  10. 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
  11. 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
  12. By: Tobias Kretschmer (London School of Economics)
    Abstract: In this paper, we study the dynamics of the market for Database Management Systems (DBMS), which is commonly assumed to possess network effects and where there is still some viable competition in our study period, 2000 – 2004. Specifically, we make use of a unique and detailed dataset on several thousand UK firms to study individual organizations’ incentives to adopt a particular technology. We find that there are significant internal complement effects – in other words, using an operating system and a DBMS from the same vendor seems to confer some complementarities. We also find evidence for complementarities between enterprise resource planning systems (ERP) and DBMS and find that as ERP are frequently specific and customized, DBMS are unlikely to be changed once they have been customized to an ERP. We also find that organizations have an increasing tendency to use multiple DBMS on one site, which contradicts the notion that different DBMS are near-perfect substitutes.
    Keywords: Database software, indirect network effects, technology adoption, microdata
    JEL: L86 O33
    Date: 2005–10
  13. By: YANNIS M. IOANNIDES (tufts university); Adriaan R. Soetevent (University of Amsterdam and Tinbergen Institute)
    Abstract: This paper examines social interactions when social networking is endogenous. It employs a linear-quadratic model that accommodates contextual e®ects, and endogenous local inter- actions, that is where individuals react to the decisions of their neighbors, and endogenous global ones, where individuals react to the mean decision in the economy, both with a lag. Unlike the simple V AR(1) structural model of individual interactions, the planner's problem here involves intertemporal optimization and leads to a system of linear di®erence equations with expectations. It highlights an asset-like property of socially optimal outcomes in every period which helps characterize the shadow values of connections among agents. Endogenous networking is easiest to characterize when individuals choose weights of social attachment to other agents. It highlights a simultaneity between decisions and patterns of social at- tachment. The paper also poses the inverse social interactions problem, asking whether it is possible to design a social network whose agents' decisions will obey an arbitrarily speci¯ed variance covariance matrix.
    JEL: D85 A14 J0
    Date: 2005–10
  14. By: Mark McCabe (Georgia Institute of Technology); Christopher Snyder (Dartmouth College)
    Abstract: Previous research modeled academic journals as platforms connecting authors with readers in a two-sided market. This research used the same basic framework also used to study telephony, credit cards, video game consoles, etc. In this paper, we focus on a key difference between the market for academic journals and these other markets: journals vary in terms of quality, where a journal's quality determined by the quality of the papers it publishes. We provide a simple model of journal quality. As an illustration of the value of the model, we use it to address issues that have arisen in the recent debate concerning whether, in the Internet age, journals should become \open access" (freely available to readers, financed by author rather than subscriber fees). Among other issues, we examine (a) whether open-access journals would tend to publish more articles than traditional journals, moving further down the quality spectrum in order to boost revenue; (b) whether journal quality affects the profitability of adopting open access; and (c) whether submission fees or acceptance fees are better instruments to extract surplus from authors.
    Keywords: Open access, academic journal, two-sided market, quality
    JEL: L14 L82 D40 L31
    Date: 2004–11
  15. 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

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