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Margit Vanberg, Pareto-relevance of network externalities in:

Margit Vanberg

Competition and Cooperation Among Internet Service Providers, page 93 - 94

A Network Economic Analysis

1. Edition 2009, ISBN print: 978-3-8329-4163-5, ISBN online: 978-3-8452-1290-6 https://doi.org/10.5771/9783845212906

Series: Freiburger Studien zur Netzökonomie, vol. 14

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93 6.1.3 Pecuniary network externalities A further distinction made in the literature on externalities is the one between pecuniary network externalities and technological network externalities (Liebowitz and Margolis, 1994: 137). As will be shown below, pecuniary network externalities are demand effects that are transmitted through the price system, whereas technological network externalities impose benefits (or costs) outside of market mechanisms. Since pecuniary externalities are common in network industries, they will be considered in more detail. Pecuniary network externalities can result from an outward shift in demand in a decreasing costs industry. When the demand shift allows the producer to reach a lower level of production costs both new consumers and existing consumers benefit from a lower price level. Formally the utility increase to existing consumers could, of course, also be illustrated by the utility function Ui,j(S,T) that was introduced at the beginning of this chapter. However, the difference to “real” external effects is that in the case of pecuniary externalities the utility increase is only indirectly related to the number of network participants. The direct relationship is between the fall in prices, induced by increased participation, and the resulting increase in consumers’ surplus. Existing consumers appropriate the increase in consumer rents as a result of a functioning price system. So, in fact, with pecuniary externalities there is no external social benefit when an additional user joins the network. In a policy context it is important to distinguish the two effects. Pecuniary externalities should not attract policy intervention because they are a part of a functioning price mechanism. Technological externalities may, however, justify policy directed at internalizing the externality. 6.1.4 Pareto-relevance of network externalities Not all correctly identified technological network externalities result in too little network participation. External effects can be inframarginal, in the sense that they would not change the equilibrium outcome, even if they were internalized into the market mechanism (Liebowitz and Margolis, 1994: 140). Inframarginal externalities are realistic when a network community profits from increasing membership only up to a critical size, but further growth beyond that point would yield no further benefit. When the critical size of the network is small relative to the number of potential members, several networks can coexist and compete for membership. Figure 6.2 is a graphic illustration of inframarginal network externalities in a static environment. The marginal social benefit from further network participation is zero once network size has reached S*. Because the private equilibrium Sp, where marginal private benefits equal marginal private costs, is to the right of S*, the socially optimal equilibrium coincides with the private equilibrium. 94 Figure 6.2: Inframarginal network externalities 6.2 General competition policy and network externalities The implementation of policy measures geared to internalizing external effects, for example the implementation of a Pigouvian tax, was traditionally considered a viable means of restoring efficient production in the presence of external effects.75 As is shown in Figure 6.1, internalizing Pareto-relevant network externalities requires that consumers gather on one uniform technology platform as long as the marginal social benefit from further network participation continues to be positive. However, when consumers derive utility not only from network size but also from product characteristics (the technology effect), internalizing network externalities in this way may not correspond to the social welfare maximizing solution. When consumers’ tastes for product characteristics differ, there may be a conflict between internalizing network externalities and catering to individual preferences. Consumers with heterogeneous tastes will not be able to agree on a single preferred set of product characteri- 75 See Baumol and Oates (1988) for an overview of the policy instruments which are applied so as to internalize external effects in the context of environmental management. p S MC MSB MBtotal MPB SpS*

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Zusammenfassung

Die Konvergenz der Netztechnologien, die dem Internet, der Telekommunikation und dem Kabelfernsehen zu Grunde liegen, wird die Regulierung dieser Märkte grundlegend verändern. In den sogenannten Next Generation Networks werden auch Sprache und Fernsehinhalte über die IP-Technologie des Internets transportiert. Mit den Methoden der angewandten Mikroökonomie untersucht die vorliegende Arbeit, ob eine ex-ante sektorspezifische Regulierung auf den Märkten für Internetdienste wettbewerbsökonomisch begründet ist. Im Mittelpunkt der Analyse stehen die Größen- und Verbundvorteile, die beim Aufbau von Netzinfrastrukturen entstehen, sowie die Netzexternalitäten, die im Internet eine bedeutende Rolle spielen. Die Autorin kommt zu dem Ergebnis, dass in den Kernmärkten der Internet Service Provider keine monopolistischen Engpassbereiche vorliegen, welche eine sektor-spezifische Regulierung notwendig machen würden. Der funktionsfähige Wettbewerb zwischen den ISP setzt jedoch regulierten, diskriminierungsfreien Zugang zu den verbleibenden monopolistischen Engpassbereichen im vorgelagerten Markt für lokale Netzinfrastruktur voraus. Die Untersuchung zeigt den notwendigen Regulierungsumfang in der Internet-Peripherie auf und vergleicht diesen mit der aktuellen Regulierungspraxis auf den Telekommunikationsmärkten in den Vereinigten Staaten und in Europa. Sie richtet sich sowohl an die Praxis (Netzbetreiber, Regulierer und Kartellämter) als auch an die Wissenschaft.