Two-Sided Market Pricing with Heterogeneous Users: Theory and App-lication

We develop a tractable model of a platform, like an app store, where heterogeneous sellers and consumers interact. Sellers vary in quality and face entry costs, while consumers differ in valuation for quality and usage intensity. The platform sets a consumer participation fee and an ad valorem commission on sellers. Two endogenous aggregates—the stock of seller quality and the value of participating consumers—create cross-side network effects. We characterize the equilibrium allocations and fees, and illustrate a key ratio of seller revenue to consumer surplus governing distortions in seller and consumer participation. The framework delivers sharp implications for current policy debates on app store regulation: commission caps or third-party payment mandates can reduce consumer surplus by raising consumer fees. If the platform owns some high-quality apps, it sets a lower commission and a higher consumer fee, reducing consumer participation. Our model also incorporates ad-financed apps, membership-financed apps, and other digital ecosystems.