Pricing and Investment by a Two-Sided Monopoly Platform

This paper analyzes a monopoly platform’s joint pricing and investment decisions in the canonical two-sided market model of Armstrong (2006). Participants are heterogeneous in outside options and derive both stand-alone benefits from joining the platform, and network benefits from interacting with the opposite side. The platform sets participation prices on both sides and chooses investments that enhance user experience. We characterize monopoly distortions in participation, pricing, and investment relative to a social planner. Taking investment as given, the monopoly outcome features under-participation on both sides, yet participation prices need not transparently reflect these participation distortions. We show that at least one participation price is excessively high relative to the social optimum. Equivalently, while one side’s participation price may be inefficiently low, participation prices that are too low on both sides are impossible. When investment enhances network benefits, marginal returns are proportional to interaction volume; since the planner induces greater participation and therefore more interactions, the monopoly underinvests on both sides. By contrast, when investment enhances stand-alone benefits, marginal returns scale with own-side participation, so investment distortions may be asymmetric across sides, although overinvestment on both sides is ruled out. An application to app platforms, with user-side device pricing and developer-side commissions on in-app purchases, yields sharp predictions for device price, commission and investment distortions, as well as for the effects of commission caps on buyer and seller surplus.