The Internet

ISP

Internet Backbone Provider

Internet Backbone Provider

Internet Backbone Provider

ISP

ISP

Big Fixed Costs in Networks

P

Q

AC

What is demand relative to scale?

P

Q

DAC

What is demand relative to scale?

P

Q

D

AC

Internet Backbone

Internet Backbone Provider A

NAPInternet Backbone

Provider C

Internet Backbone Provider B

Sequential Monopoly Broadband service made up of Access and

ISP Assumption of no monopsony power for now

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

Sequential Monopoly (Con’t) Demand for Broadband (Final product)

P = 200 – 10Q

Access provider bundles and setsMRbband = MCaccess+ Pisp

So Pisp = MRbband -MCaccess

Sequential Monopoly (con’t)

$

Q

D

Broadband Demand

Sequential Monopoly (con’t)

$

Q

D

Broadband Demand

MRbband

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

MCaccess

Pisp = MRbband -MCaccess

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

MCaccess

Pisp = MRbband -MCaccess

MRisp

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

MCaccess

Pisp = MRbband -MCaccess

MRisp

MCisp

Q

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

P*

Disp

MRisp

MCisp

Q*

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

P*

Disp

MRisp

MCisp

Q*

MCbband

P**

Q**

Sequential Monopoly MathDbband: P = 200 - 10Q

MCisp = 10

MCaccess= 20

Disp= 200 – 20Q – 20 = 180 –20Q

Set MRisp = MCisp 180 – 40Q = 10

Q = 4.25 Pisp = 95, Pbband = 157.5

Solve single monopoly and get Q = 8.5, P= 115.

Sequential Monopoly Profits

isp = (P-MC)* Q = (95 –10)* 4.25 = 361.25

access = (157.5 – 95 - 20)* 4.25 = 180.625

Total = 541.875

Single Monopoly Profits:

monop = (115 – 30)*8.5 = 722.5

Overall welfare increases in this case

Sequential Monopoly (con’t)$

Q

D

Broadband Demand

MRbband

P*

Disp

MRisp

MCisp

Q*

MCbband

P**

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 Q’s

Incentive to Squeeze? If Qmarket stays the same, then if

(PD- CD)> (Pu- Cu)

Qmarket ↑

Qmarket ↓

Sequential Monopoly Assumed 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

SRMC

c

D

Qs

c + K

Congestion Pricing

$

Q

SRMC

c

D

Qs

c + K

Q*

Peak Load Pricing

$

Q

SRMC

c

Dpeak

Qs

c + K

Doff peak

Without Peak Pricing

$

Q

SRMC

c

Dpeak

Qs

c + K

Doff peak

P*

Loss from overcapacityLoss from

overpricing

QOQp

What Does Peak Pricing Do?

Low value users stop or shift e-mail

High value users get priority (and pay) video conferencing

Shifting Peaks

$

Q

Dpeak

c + K

Doff peak

QOffQPeak

LRMC

Demand forcapacity

Q*

POff

PPeak