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Two-Sided Platforms: Pricing and Social Efficiency

  • Andrei Hagiu
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    This paper models two-sided market platforms, which connect third-party suppliers (developers) of many different products and services to users who demand a variety of these products. From a positive perspective, our model provides a simple explanation for the stark differences in platform pricing structures observed across a range of industries, including software for computers and an increasing number of electronic devices, videogames, digital media, etc. We show that the optimal platform pricing structure shifts towards making a larger share of profits on developers when users have a stronger preference for variety and also when there is uncertainty with respect to the availability, or a limited supply, of third-party (high-quality) products. From a normative perspective, we show that the increasingly popular public policy presumption that open platforms are inherently more efficient than proprietary ones -in terms of induced product diversity, user adoption and total social welfare- is not justified in our framework. The key welfare tradeoff is between the extent to which a proprietary platform internalizes business-stealing, product diversity and indirect network effects and the two-sided deadweight loss it creates through monopoly pricing.

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    File URL: http://www.rieti.go.jp/jp/publications/dp/04e035.pdf
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    Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 04035.

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    Length: 45 pages
    Date of creation: Dec 2004
    Date of revision:
    Handle: RePEc:eti:dpaper:04035
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    1. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
    2. Michael R. Baye & John Morgan, 2001. "Information Gatekeepers on the Internet and the Competitiveness of Homogeneous Product Markets," American Economic Review, American Economic Association, vol. 91(3), pages 454-474, June.
    3. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
    4. Jean-Charles Rochet & Jean Triole, 2002. "Platform competition in two sided markets," LSE Research Online Documents on Economics 24929, London School of Economics and Political Science, LSE Library.
    5. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
    6. Church, Jeffrey & Gandal, Neil & Krause, David, 2003. "Indirect Network Effects and Adoption Externalities," CEPR Discussion Papers 3738, C.E.P.R. Discussion Papers.
    7. Simon P. Anderson & Stephen Coate, 2003. "Market Provision of Broadcasting: A Welfare Analysis," Virginia Economics Online Papers 358, University of Virginia, Department of Economics.
    8. David S. Evans & Andrei Hagiu & Richard Schmalensee, 2004. "A Survey of the Economic Role of Software Platforms in Computer-Based Industries," CESifo Working Paper Series 1314, CESifo Group Munich.
    9. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    10. Spence, Michael, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 217-35, June.
    11. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
    12. Andrei Hagiu, 2004. "Two-Sided Platforms: Pricing and Social Efficiency - Extensions," Discussion papers 04036, Research Institute of Economy, Trade and Industry (RIETI).
    13. Pashigian, B Peter & Gould, Eric D, 1998. "Internalizing Externalities: The Pricing of Space in Shopping Malls," Journal of Law and Economics, University of Chicago Press, vol. 41(1), pages 115-42, April.
    14. Marc Rysman, 2004. "Competition Between Networks: A�Study of the Market for Yellow�Pages," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 483-512, 04.
    15. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
    16. Josh Lerner & Jean Tirole, 2002. "Efficient Patent Pools," NBER Working Papers 9175, National Bureau of Economic Research, Inc.
    17. Stahl, Dale O, II, 1988. "Bertrand Competition for Inputs and Walrasian Outcomes," American Economic Review, American Economic Association, vol. 78(1), pages 189-201, March.
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