Competition Policy in Network Industry

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usNET Institute*
www.NETinst.org

Working Paper #04-23
Revised June 2004
Competition Policy in Network Industries: An Introduction
Nicholas Economides
Stern School of Business, New York University

* The Networks, Electronic Commerce, and Telecommunications (“NET”) Institute, http://www.NETinst.org, is a non-profit institution devoted to research on network industries, electronic commerce, telecommunications, the Internet, “virtual networks” comprised of computers that share the same technical standard or operating system, and on network issues in general.

Competition Policy In Network Industries:
An Introduction*
By Nicholas Economides**
June 2004
Abstract
We discuss issues of the application of antitrust law and regulatory rules to network industries. In assessing the application of antitrust in network industries, we analyze a number of relevant features of network industries and the way in which antitrust law and regulatory rules can affect them. These relevant features include (among others) network effects, market structure, market share and profits inequality, choice of technical standards, relationship between the number of active firms and social benefits, existence of market power, leveraging of market power in complementary markets, and innovation races. We find that there are often significant differences on the effects of application of antitrust law in network and non-network industries.

Key words:

networks, network effects, public policy, antitrust, telecommunications, technical standards

JEL Classification: L4. L5

* I thank Brian Viard, Larry White and the participants at the conference “The New Economy: Just How New is It?” at Texas A&M for their helpful comments and suggestions.
** Stern School of Business, New York University, New York, NY 10012, (212) 9980864, fax (212) 995-4218, http://www.stern.nyu.edu/networks/, e-mail: neconomi@stern.nyu.edu.

Competition Policy In Network Industries: An Introduction
Contents
Introduction ............................................................................................................... 3 The Logic of Competition Law ................................................................................ 3 Special Features of Markets with Network Effects ............................................... 4 3.1

Sources of Network Effects and the Reversal of the Law of Demand.......... 4 3.2
Critical Mass.................................................................................................... 10 3.3
Features of Markets with Network Effects................................................... 10 3.3.1
Ability to Charge Prices on Both Sides of a Network .......................... 10 3.3.2
Externalities Internalized or Not ........................................................... 11 3.3.3
Fast Network Expansion ........................................................................ 11 3.3.4
Inequality of Market Shares and Profits .............................................. 12 3.3.5
Monopoly May Maximize Total Surplus .............................................. 14 3.3.6
No Anti-Competitive Acts are Necessary to Create Market Inequality 14
3.3.7
In Network Industries, Free Entry Does Not Lead to Perfect
Competition ............................................................................................................. 15 3.3.8
Imposing a “Competitive” Market Structure is Likely to Be Counterproductive .................................................................................................. 15 3.3.9
Nature of Competition is Different in Network Industries ................. 16 3.3.10
Path Dependence ..................................................................................... 16 4. Competition Policy Issues in Network Industries ................................................ 17 4.1

One-sided Bottlenecks...
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