1. Chapter Thirty-Four Information Technology

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 many people use the same software.

3. Information Technologies • But then switching technologies becomes very costly -- lock-in. • E.g. Microsoft Windows. • How do markets operate when there are switching costs or network externalities?

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. • Rate of interest is r.

5. Competition & Switching Costs • All producers set the same nondiscounted price of p per month. • When is switching producers rational for a customer?

6. Competition & Switching Costs • Cost of not switching is

7. Competition & Switching Costs • Cost of not switching is • Cost from switching is

8. Competition & Switching Costs • Cost of not switching is • Cost from switching is • Switch if

9. Competition & Switching Costs • Cost of not switching is • Cost from switching is • Switch if • I.e. if

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 

11. Competition & Switching Costs • At equilibrium, producer economic profits are zero. • I.e.

12. Competition & Switching Costs • At equilibrium, producer economic profits are zero. • I.e. • Since , at equilibrium

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.

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 nv, where n is the number of persons who buy the good.

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 demanded of the good?

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. • So inverse demand is p = n(1000-n).

17. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve 0 1000 n

18. Competition & Network Externalities • Suppose all suppliers have the same marginal production cost, c.

19. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Supply Curve c 0 1000 n

20. Competition & Network Externalities • What are the market equilibria?

21. Competition & Network Externalities • What are the market equilibria? • (a) No buyer buys, no seller supplies. • If n = 0, then value nv = 0 for all buyers v, so no buyer buys. • If no buyer buys, then no seller supplies.

22. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve (a) Supply Curve c 0 1000 n

23. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve (a) Supply Curve c n’ 0 1000 n

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 • good is bought only by buyers with n’v  c; i.e. only large v  v’ = c/n’.

25. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve (a) Supply Curve c (b) (c) n’ n” 0 1000 n

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” = c/n”.

27. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve (a) Supply Curve c (b) (c) n’ n” 0 1000 n Which equilibrium is likely to occur?

28. Competition & Network Externalities • Suppose the market expands whenever willingness-to-pay exceeds marginal production cost, c.

29. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Supply Curve c n’ n” 0 1000 n Which equilibrium is likely to occur?

30. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Unstable Supply Curve c n’ n” 0 1000 n Which equilibrium is likely to occur?

31. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Supply Curve c n” 0 1000 n Which equilibrium is likely to occur?

32. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Stable Supply Curve c n” 0 1000 n Which equilibrium is likely to occur?

33. Competition & Network Externalities Willingness-to-pay p = n(1000-n) Demand Curve Stable Stable Supply Curve c n” 0 1000 n Which equilibrium is likely to occur?

34. Rights Management • Should a good be • sold outright, • licensed for production by others, or • rented? • How is the ownership right of the good to be managed?

35. Rights Management • Suppose production costs are negligible. • Market demand is p(y). • The firm wishes to

36. Rights Management

37. Rights Management

38. Rights Management

39. Rights Management • The rights owner now allows a free trial period. This causes • an increase in consumption

40. Rights Management • The rights owner now allows a free trial period. This causes • an increase in consumptionand a decrease in sales per unit of consumption

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

43. Rights Management • The firm’s problem is now to

44. Rights Management • The firm’s problem is now to • This problem must have the same solution as

45. Rights Management • The firm’s problem is now to • This problem must have the same solution as • So

46. Rights Management

47. Rights Management  higher profit

48. Rights Management  lower profit

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 profitable than selling for personal use only?

50. 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