Arun Sundararajan

Stern School of Business, NYU

Abstract

This talk presents a model of monopoly pricing for a network good, with heterogeneous customer preferences over both the intrinsic value and the network value of the product. Network effects that depend on gross consumption, individual consumption, and customer type are analyzed. It is shown that network effects generally raise total prices, and may either raise individual consumption for all customer types, lower it for a subset of customer types, or leave it unchanged. These differences highlight the nature of the trade-off between value creation and price discrimination when pricing network goods. The monopolist typically captures all the direct value from the network effects. Customer surplus may increase for those whose individual consumption increases. Consequently, network effects may actually harm low-usage customers, and skew the distribution of surplus towards higher-end users.

When the monopolist prices to deter entry, the socially optimal outcome is obtained when network value is constant across customers. On the other hand, when network value is high and depends on individual consumption, the threat of entry has no effect on total welfare, and merely redistributes surplus between the monopolist and the customers. In other cases, optimal consumption increases for a subset of lower-type customers, which mitigates the skew in surplus across customers.

Some of these results suggest that from a policy perspective, ensuring a credible threat of entry may be more socially efficient than actually inducing entry. Other implications, along with examples that illustrate the nature of the pricing function for different distributions, may also be discussed.