The rights owner now allows a free. trial period.[r]
(1)Chapter Thirty-Four
(2)Information Technologies
Computers, answering machines, FAXes, pagers, cellular phones, … Many provide strong
complementarities.
E.g email is useful only if lots of
people use it a network externality. And computers are more useful if
(3)Information Technologies
But then switching technologies
becomes very costly lock-in.
E.g Microsoft Windows.
How markets operate when there
(4)Competition & Switching Costs
Producer’s cost per month of
providing a network service is c per customer.
Customer’s switching cost is s. Producer offers a one month
discount, d.
(5)Competition & Switching Costs
All producers set the same
nondiscounted price of p per month.
When is switching producers rational
(6)Competition & Switching Costs
Cost of not switching is p p
r
(7)Competition & Switching Costs
Cost of not switching is
Cost from switching is
p p r
.
p d p
r s
(8)Competition & Switching Costs
Cost of not switching is
Cost from switching is
Switch if
p p r
.
p d p
r s p
p r
.
p d p
r s
(9)Competition & Switching Costs
Cost of not switching is
Cost from switching is
Switch if
I.e if
p p r
.
p d p
r s p
p r
.
p d p
r s
.
(10)Competition & Switching Costs
Switch if
I.e if
Producer competition will ensure at a
market equilibrium that customers are indifferent between switching or not
p d p
r s p
p r
.
d s.
(11)Competition & Switching Costs
At equilibrium, producer economic
profits are zero.
I.e p d c p c
r
(12)Competition & Switching Costs
At equilibrium, producer economic
profits are zero.
I.e
Since , at equilibriumd s
p d c p c
r
0.
p c p c
r s
(13)Competition & Switching Costs
At equilibrium, producer economic
profits are zero.
I.e
Since , at equilibrium
I.e present-valued producer profit =
consumer switching cost. d s
p d c p c
r
0.
p c p c
r s
(14)Competition & Network Externalities
Individuals 1,…,1000.
Each can buy one unit of a good
providing a network externality.
Person v values a unit of the good at
(15)Competition & Network Externalities
Individuals 1,…,1000.
Each can buy one unit of a good
providing a network externality.
Person v values a unit of the good at
nv, where n is the number of persons who buy the good.
At a price p, what is the quantity
(16)Competition & Network Externalities
If v is the marginal buyer, valuing the
good at nv = p, then all buyers v’ > v value the good more, and so buy it.
Quantity demanded is n = 1000 - v.
(17)Competition & Network Externalities
0 1000
n Willingness-to-pay
p = n(1000-n)
(18)Competition & Network Externalities
Suppose all suppliers have the same
(19)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
c
(20)Competition & Network Externalities
(21)Competition & Network Externalities
What are the market equilibria?
(a) No buyer buys, no seller supplies.
– If n = 0, then value nv = for all buyers v, so no buyer buys.
(22)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
(a) c
(23)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n’ (a) c
(24)Competition & Network Externalities
What are the market equilibria? (b) A small number, n’, of buyers
buy.
– small n’ small network externality value n’v
(25)(26)Competition & Network Externalities
What are the market equilibria?
(c) A large number, n”, of buyers buy.
– Large n” large network externality value n”v
– good is bought only by buyers with n’v c; i.e up to small v v” =
(27)(28)Competition & Network Externalities
Suppose the market expands
whenever willingness-to-pay
(29)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n’ n”
c
(30)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n’ n”
c
Which equilibrium is likely to occur?
Willingness-to-pay p = n(1000-n)
(31)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n” c
(32)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n” c
Which equilibrium is likely to occur?
Willingness-to-pay p = n(1000-n)
(33)Competition & Network Externalities
0 1000
n
Demand Curve
Supply Curve
n” c
Willingness-to-pay p = n(1000-n)
Stable
(34)Rights Management
Should a good be sold outright,
licensed for production by
others, or
rented?
How is the ownership right of the
(35)Rights Management
Suppose production costs are
negligible.
Market demand is p(y). The firm wishes to max
(36)Rights Management
y p
(37)Rights Management
y p
p y( )
(38)Rights Management
y * y
p
p y( )
( )y p y y( )
(39)Rights Management
The rights owner now allows a free
trial period This causes
(40)Rights Management
The rights owner now allows a free
trial period This causes
– an increase in consumption
and a decrease in sales per unit of consumption
y Y
.
(41)Rights Management
The rights owner now allows a free
trial period This causes
– increase in value to all users increase in willingness-to-pay;
(42)Rights Management
y Y,
p
p y( )
(43)Rights Management
The firm’s problem is now to
max
Y P Y
Y
p Y Y p Y Y
( ) ( ) ( )
(44)Rights Management
The firm’s problem is now to
This problem must have the same
solution as max
y p y y( ) max
Y P Y
Y
p Y Y p Y Y
( ) ( ) ( )
(45)Rights Management
The firm’s problem is now to
This problem must have the same
solution as
So
max
y p y y( )
y* Y*. max
Y P Y
Y
p Y Y p Y Y
( ) ( ) ( )
(46)Rights Management
y p
p y( )
( )y p y y( )
y *
(47)Rights Management
y* Y*
p y( *) p Y( *)
y p
p y( )
( )y p y y( )
( )Y p Y Y( )
(48)Rights Management
y* Y*
p y( *) p Y( *)
y p
p y( )
( )y p y y( )
( )Y p Y Y( )
(49)Sharing Intellectual Property
Produce a lot for direct sales, or only a little for multiple rentals?
Lending books, software. Renting tools, videos etc.
Sell movies directly, or only sell to video rental stores, or pay-per-view? When is selling for rental more
(50)Sharing Intellectual Property
F is the fixed cost of designing the
good.
c is the constant marginal cost of
copying the good.
(51)Sharing Intellectual Property
F is the fixed cost of designing the
good.
c is the constant marginal cost of
copying the good.
p(y) is the market demand. Direct sales problem is to
max
(52)Sharing Intellectual Property
Is selling for rental more profitable? Each rental unit is used by k >
consumers.
So y units sold x = ky consumption
(53)Sharing Intellectual Property
Is selling for rental more profitable? Each rental unit is used by k >
consumers.
So y units sold x = ky consumption
units.
Marginal consumer’s
(54)Sharing Intellectual Property
Is selling for rental more profitable?
Each rental unit used by k > consumers. So y units sold x = ky consumption
units.
Marginal consumer’s willingness-to-pay is p(x) = p(ky).
(55)Sharing Intellectual Property
Rental transaction cost t reduces
willingness-to-pay to p(ky) - t.
Rental store’s willingness-to-pay is
(56)Sharing Intellectual Property
Rental transaction cost t reduces
willingness-to-pay to p(ky) - t.
Rental store’s willingness-to-pay is
Producer’s sale-for-rental problem is
P ys ( ) k p ky[ ( ) t].
P y y cy Fs ( )
(57)Sharing Intellectual Property
Rental transaction cost t reduces
willingness-to-pay to p(ky) - t.
Rental store’s willingness-to-pay is
Producer’s sale-for-rental problem is
P ys ( ) k p ky[ ( ) t].
P y y cy Fs ( ) k p ky[ ( ) t y cy F]
(58)Sharing Intellectual Property
Rental transaction cost t reduces
willingness-to-pay to p(ky) - t.
Rental store’s willingness-to-pay is
Producer’s sale-for-rental problem is
P ys ( ) k p ky[ ( ) t].
P y y cy F k p ky t y cy F p ky ky c
k t ky F
s ( ) [ ( ) ]
( ) .
FH IK
(59)Sharing Intellectual Property
p ky ky c
k t ky F p x x c
k t x F
( ) ( )
FH IK FH IK
max y
is the same problem as the direct sale problem max
y p y y cy F( ) max
x
(60)Sharing Intellectual Property
p ky ky c
k t ky F p x x c
k t x F
( ) ( )
FH IK FH IK
max y
is the same problem as the direct sale problem max
y p y y cy F( ) max
x
except for the marginal costs Direct sale is better for the producer if c c
k t
(61)Sharing Intellectual Property
Direct sale is better for the producer if
I.e if
c c
k t
.
c k
k t
(62)Sharing Intellectual Property
Direct sale is better for the producer if
Direct sale is better if
– replication cost c is low
– rental transaction cost t is high – rentals per item, k, is small.
c k
k t