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The economics of network neutrality

Author

Listed:
  • Nicholas Economides
  • Benjamin E. Hermalin

Abstract

Pricing of Internet access has been characterized by two properties. Parties are directly billed only by the Internet Service Provider (ISP) through which they connect to the Internet and the ISP charges them on the basis of the amount of information transmitted rather than its content. These properties define a regime known as “network neutrality.” In 2005, some large ISPs proposed that application and content providers directly pay them additional fees for accessing the ISPs’ residential clients, as well as differential fees for prioritizing certain content. We analyze the private and social incentives to introduce such fees when the network is congested and more traffic implies delays. We find that network neutrality is welfare superior to bandwidth subdivision (granting or selling priority service). We also consider the welfare properties of the various regimes that have been proposed as alternatives to network neutrality. In particular, we show that the benefit of a zero-price “slow lane” is a function of the bandwidth the regulator mandates be allocated it. Extending the analysis to consider ISPs’ incentives to invest in more bandwidth, we show that, under general conditions, their incentives are greatest when they can price discriminate; this investment incentive offsets to some degree the allocative distortion created by the introduction of price discrimination. A priori, it is ambiguous whether the offset is sufficient to justify departing from network neutrality.
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Suggested Citation

  • Nicholas Economides & Benjamin E. Hermalin, 2012. "The economics of network neutrality," RAND Journal of Economics, RAND Corporation, vol. 43(4), pages 602-629, December.
    • Handle: RePEc:bla:randje:v:43:y:2012:i:4:p:602-629
    DOI: 1756-2171.12001
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    References listed on IDEAS

    as
    1. Jay Pil Choi & Byung‐Cheol Kim, 2010. "Net neutrality and investment incentives," RAND Journal of Economics, RAND Corporation, vol. 41(3), pages 446-471, September.
    2. Economides, Nicholas & Tåg, Joacim, 2012. "Network neutrality on the Internet: A two-sided market analysis," Information Economics and Policy, Elsevier, vol. 24(2), pages 91-104.
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    More about this item

    JEL classification:

    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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