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  • The Internet

  • Big Fixed Costs in NetworksPQAC

  • What is demand relative to scale?PQDAC

  • What is demand relative to scale?PQDAC

  • Internet BackboneInternet Backbone Provider ANAPInternet Backbone Provider CInternet Backbone Provider B

  • Sequential MonopolyBroadband service made up of Access and ISPAssumption of no monopsony power for now

    Demand for Broadband (Final product)P = 200 10Q

  • Sequential Monopoly (Cont)Demand for Broadband (Final product)P = 200 10Q

    Access provider bundles and setsMRbband = MCaccess+ PispSo Pisp = MRbband -MCaccess

  • Sequential Monopoly (cont)$QDBroadband Demand

  • Sequential Monopoly (cont)$QDBroadband DemandMRbband

  • Sequential Monopoly (cont)

  • Sequential Monopoly (cont)

  • Sequential Monopoly (cont)$QDBroadband DemandMRbbandMCaccessPisp = MRbband -MCaccessMRispMCispQ

  • Sequential Monopoly (cont)$QDBroadband DemandMRbbandP*DispMRispMCispQ*

  • Sequential Monopoly (cont)$QDBroadband DemandMRbbandP*DispMRispMCispQ*MCbbandP**Q**

  • Sequential Monopoly MathDbband: P = 200 - 10QMCisp = 10MCaccess= 20Disp= 200 20Q 20 = 180 20QSet MRisp = MCisp 180 40Q = 10Q = 4.25 Pisp = 95, Pbband = 157.5Solve single monopoly and get Q = 8.5, P= 115.

  • Sequential Monopoly Profitsisp = (P-MC)* Q = (95 10)* 4.25 = 361.25access = (157.5 95 - 20)* 4.25 = 180.625Total = 541.875

    Single Monopoly Profits:monop = (115 30)*8.5 = 722.5Overall welfare increases in this case

  • Sequential Monopoly (cont)$QDBroadband DemandMRbbandP*DispMRispMCispQ*MCbbandP**Q**Increased Profit

  • Price Squeeze?

    = (Pu- Cu)*QO + (PD- CD)*Qi(1)where QO is quantity of others and Qi is firm quantity

    If firm sells no upstream, QO = 0 = (PD- CD)*Qi(0)

    Decision depends on PC margins and Qs

  • Incentive to Squeeze?If Qmarket stays the same, then if (PD- CD)> (Pu- Cu)

    Qmarket

    Qmarket

  • Sequential MonopolyAssumed fixed proportions

    Markup can lead to inefficient substitution

    Price can rise or fall in this case

  • Congestion

    Too much traffic

    Drop packets or delay delivery

    Pricing solutions

  • Congestion Pricing$Q

  • Congestion Pricing$QQsc + K

  • Peak Load Pricing$Q

  • Without Peak Pricing$QP*QOQp

  • What Does Peak Pricing Do?

    Low value users stop or shifte-mail

    High value users get priority (and pay)video conferencing

  • Shifting Peaks$Qc + KQOffQPeakLRMC

    What happens if demand is above the short run marginal cost and the cost of capacity?

    Should have higher output because the value of the output is higher than cost of operation and construction.

    This means that capacity should be Q*, not Qs.

    Loss from being too small in capacity is the triangle. Total value is the incremental area underneath the demand curve. But the cost is the rectangle, leaving the triangle for net gain from expansion

    Pricing would be differentprice would decline from above c+K to c+K