Network Competition IS250 Spring 2010 chuang@ischool.berkeley.edu

Network Competition

IS250Spring 2010

chuang@ischool.berkeley.edu

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Network Competition

Design for Choice Design for Competition

Loci of Competition- Who, what, and where

Models of Competition- Quantify benefits of competition

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Loci of CompetitionA 2x2 Network Model

Edge Core

Logical/ Service

Internet Service Providers (ISPs)

Internet Backbone Operators

Physical

Last-mile access networks

Wide-area transit networks

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Models of Competition

Monopoly Perfect Competition Oligopoly

Many other models to capture “messiness” of the real-world, e.g., incomplete information, asymmetric information, bounded rationality, transactional costs, externalities, …

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Preliminaries

Agents: e.g., buyers and sellers Commodity: goods, services Market: to facilitate trade Utility: measure of satisfaction derived from trade

Equilibrium: predicted outcome

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Utility

Seller’s utility = profit () = revenue - cost- revenue = price * quantity- cost includes fixed and marginal costs

Buyer’s utility = valuation - price- Valuation aka willingness-to-pay (WTP)

Utility maximization- Seller i sets Pi and/or Qi to maximize profit- Buyer j decides which product, if any, to purchase

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Demand

w

q

Willingness to pay (WTP)

Marginal WTP: w(q)

…

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w

q

Amount paid (producer’s revenue)

q

p

Consumer surplus

w(q)

Consumer Surplus

Not every consumer may be served, even if their WTP > 0 Results in dead-weight loss (DWL)

DWL

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Supply

c(q)

q

Production cost function: c(q) Fixed cost = c(0) = F

F

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Marginal Cost

m(q)

q

Total cost (excluding fixed cost)

q

Marginal cost: m(q) = c’(q)

Marginal cost curve

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Producer Surplus

$

q

Marginal cost

q

Profit = revenue - cost = p·q - c(q) Producer surplus excludes fixed cost Example: for constant marginal cost function:

- Profit = (p-m)·q - c(0)- Producer surplus = (p-m)·q

Marginal WTP

m

pPS

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Social Surplus

w

q

Marginal cost

q

Also known as social welfare or total surplus SS = CS + PS

Marginal WTP

m

pCS

PS

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Monopoly v. Competition

What are the tradeoffs?

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Monopoly

Single producer -- free to set prices to maximize profit (usually at the expense of social welfare)

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Monopoly Example

Cost: c(q) = c- Zero marginal cost

Linear Demand: p(q) = 1 - q

Profit: = p·q - c Producer surplus: PS = p·q Profit maximization:

- Solve the equation d/dq = 0- q* = 1/2; p* = 1/2 = 1/4 - c

Consumer surplus, CS = 1/8 Social welfare = CS + PS = 3/8 Q: when will monopolist choose not to produce?

q

p

1

1

p(q) = 1 - q

q*

p*

Dead Weight Loss (DWL)

Consumer Surplus

Producer Revenue

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Perfect Competition

No dominant supplier- Price determined by the market, i.e., all suppliers are price takers

Competition drives price down to marginal cost- In example: p* = MC = 0 --> q* = 1- Profit, = -c- Producer surplus = 0- Consumer surplus, CS = 1/2- Social welfare = 1/2

Perfect competition maximizes social welfare, but suppliers cannot recover fixed cost

q

p

1

D

q*=1p* = 0

Consumer Surplus

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Monopoly v. Competition

What are the tradeoffs?

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Oligopoly

Competitive market with small number of suppliers- Duopoly is special case, though common in many telecommunication sectors

Common oligopoly models, analyzed as games:- Bertrand competition: price competition- Cournot competition: quantity competition- Stackelberg competition: leader follower game

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Stackelberg Game

Duopoly game played in two steps:- Supplier 1 (leader) first choose

quantity q1

- Given q1, supplier 2 (follower) choose q2 as best response

Game solved backwards, starting with supplier 2 Example: qi in [0,1], p = 1-q, ci = 0

- Supplier 2: max 2 = q2(1-q1-q2) --> q2 = (1-q1)/2

- Supplier 1: max 1 = q1(1-q1-q2) --> q1 = 1/2

- (q1,q2) = (1/2, 1/4) is Nash equilibrium

Q: how does this compare with the cases of monopoly and perfect competition?

q

p

1

1

p(q) = 1 - q

q*

p*

Dead Weight Loss (DWL)

Consumer Surplus

Producer Revenue

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Summary: Monopoly,Duopoly, andPerfect Competition

Q* P* Producer Surplus

Consumer Surplus

Total Surplus

Dead Weight Loss

Monopoly 0.5 0.5 0.25 0.125 0.375 0.125

Duopoly (Stackelberg)

0.75 0.25 0.1875 0.28125 0.46875 0.03125

Perfect Competition

1 0 0 0.5 0.5 0

q

p

1

1

p(q) = 1 - q

q*

p*

Dead Weight Loss (DWL)

Consumer Surplus

Producer Revenue

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Summary

Degree of competition matters! Whereas perfect competition can be ruinous to industries with low marginal cost (strong economies of scale)…

Oligopolistic competition can allow providers a path to cost recovery and profitability, while also avoiding the pitfalls of a monopoly

Actual social welfare realization depends on the actual shapes of the demand and supply curves