Differentiated Networks: Equilibrium and Efficiency
AbstractWe consider a model of price competition in a duopoly with product differentiation and network effects. The value of a good for a consumer is the sum of a common and an idiosyncratic component. The first captures the vertical dimension of quality, the second captures horizontal differentiation. Each consumer privately observes his own value for each good, but cannot separate the common and the idiosyncratic component. Therefore, he has incomplete information about the value of the goods for the other consumers. After firms announce prices, consumers choose simultaneously which network to join, facing a coordination problem. In the efficient allocation, both networks are active and the firm with the highest expected quality has the largest market share. To characterize the equilibrium allocation, we derive necessary and sufficient conditions for uniqueness of the equilibrium of the coordination game played by consumers for given prices. The equilibrium allocation differs from the efficient one for two reasons. First, the equilibrium allocation of consumers to the networks is too balanced, since consumers fail to internalize network externalities. Second, if access to the networks is priced by strategic firms, then the product with the highest expected quality is also the most expensive. This further reduces the asymmetry between market shares and therefore social welfare.
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Bibliographic InfoPaper provided by University of Essex, Department of Economics in its series Economics Discussion Papers with number 638.
Date of creation: 18 Sep 2007
Date of revision:
Postal: Discussion Papers Administrator, Department of Economics, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, U.K.
Other versions of this item:
- Rossella Argenziano, 2008. "Differentiated networks: equilibrium and efficiency," RAND Journal of Economics, RAND Corporation, vol. 39(3), pages 747-769.
- NEP-ALL-2007-09-24 (All new papers)
- NEP-COM-2007-09-24 (Industrial Competition)
- NEP-MIC-2007-09-24 (Microeconomics)
- NEP-NET-2007-09-24 (Network Economics)
- NEP-SOC-2007-09-24 (Social Norms & Social Capital)
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