Chapter 16
Competing for Monopoly:
The Economics of
Network Goods
Third Edition
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.
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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.
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Definition
Network good:
a good whose value to one consumer
increases the more other consumers
use the good.
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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.
Answer: b
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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”.
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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
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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
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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.
Answer: a
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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
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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.
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Coordination Game
Alex and Tyler can
choose either Apple
or Microsoft software
Alex
Tyler
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
Alex’s choices are the rows.
Tyler’s choices are the columns.
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Coordination Game
Tyler
Alex
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
Alex’s payoff
Tyler’s payoff
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Coordination Game
Tyler
Alex
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
If they use different software, it is difficult
to work together (low payoffs).
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Coordination Game
Tyler
Alex
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
If they use the same software, it is easier
to work together (high payoffs).
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Coordination Game
Tyler
Alex
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
If both choose the same software, neither
has an incentive to change.
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Definition
Sony
Toshiba
HD-DVD
Blu-Ray
HD-DVD
(10, 8)
(0, 0)
Blu-Ray
(0, 0)
(8,10)
Other examples in standards wars:
VHS vs Betamax
Blu-Ray vs HD_DVD
Before the Blu-Ray standard was adopted, the
benefits of the market were largely unrealized
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Definition
Nash Equilibrium:
A situation in which no player has an
incentive to change his or her strategy
unilaterally.
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Coordination Game
Tyler
Alex
Apple
Microsoft
Apple
(11, 11)
(3, 3)
Microsoft
(3, 3)
(10, 10)
With TWO equilibria, the choice is often
determined by “accidents of history”.
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Nash Equilibrium
Cell Phone Duopoly
P
Q
$0
140
5
130
10
120
 The “good”: cell phone service with
15
110
20
100
unlimited anytime minutes and free
phone
25
90
 Smalltown’s demand schedule at left
30
80
35
70
 Two firms: T-Mobile, Verizon
40
60
45
50
 Smalltown has 140 residents
(duopoly: an oligopoly with two firms)
 Each firm’s costs: FC = $0, MC = $10
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Nash Equilibrium
Competitive
outcome:
P = MC = $10
Q = 120
Profit = $0
Monopoly
outcome:
P = $40
Q = 60
Profit = $1,800
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Nash Equilibrium
T-Mobile and Verizon could agree to each produce half of
the monopoly output:
For each firm: Q = 30, P = $40, profits = $900
Does anyone have an incentive to cheat?
What if Verizon increases Q to 40?
Market demand curve now has Q = 70  P = $35
Verizon profit = TR – TC = 40*$35 - ($10* 40) = $1000
T-Mobile profit = (30*$35) – ($10*30) = 750
Verizon gains profit, T-Mobile loses profit
Will Verizon cheat? Why wouldn’t they? Profits increase
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Nash Equilibrium
What will T-Mobile do in response? Will it gain if it
cheats?
Suppose T-Mobile increases its Q to 40
Now market Q = 80 and market price falls to $30
What is T-Mobile’s profit? (40*$30) – (40*10) = $800
Will T-Mobile increase its Q?
Yes, since its profits increase from $750 to $800
Note that Verizon’s profits fall from $1000 to $800
Verizon cheats and increase profits, T-Mobile profits fall
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Nash Equilibrium
Is there an incentive to cheat at this point?
Suppose Verizon increases output to 50Q
Market Q rises to 90 and market price falls to $25
What is Verizon’s profit?
• (50 * $25) – (50 * $10) = $750 (down from $800)
Does Verizon have any incentive to cheat? No
Does T-Mobile have any incentive to cheat? No
What if either company cuts production to 40Q?
Both companies are worse off if they move
away from producing 40Q.
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Nash Equilibrium
Verizon and T-Mobile are now at a Nash equilibrium
A Nash equilibrium is a situation in which
no player has an incentive to change their
strategy unilaterally
 By cooperating (30 Q each) they could have made
more profit
 Both companies are in a less profitable position
 Prisoner’s dilemma
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Markets for Network Goods
TOSHIK/SHUTTERSTOCK
The Dvorak keyboard, developed in the 1930s
 The current QWERTY keyboard may not
be the best design
 QWERTY came first and got locked in
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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
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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.
Answer: c
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Markets for Network Goods
3. Competition “for the market”
 Consumer loyalties can switch quickly
 A monopoly can easily change hands
 1988: Lotus 1-2-3 had 70% of the
spreadsheet market
 1998: Excel had 70% of the market
 Results in serial monopolies
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Definition
Contestable Market:
A market in which the threat of potential
competition is enough to make it
behave competitively.
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Contestable Market:
Markets are more contestable when:
1. Fixed costs of market entry are low,
relative to potential revenue.
2. There are few or no legal barriers to entry.
3. The incumbent has no unique, hard-toreplicate resource.
4. Consumers are open to the prospect of
dealing with a new competitor.
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Contestable Market:
 Large market share does not necessarily
mean the firm’s position is safe…
 How contestable is Facebook’s market?
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Self-Check
Which of the following is most likely to
operate in a contestable market?
a. Railroad.
b. Pharmaceutical company.
c. Restaurant.
Answer: c
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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
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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
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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
 Normal market share percentages
analysis does not apply
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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
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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
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