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Benefits and Pitfalls of Network Interconnection

  • Nicholas S. Economides
  • Glenn A. Woroch

This paper assesses the private and social incentives for disjoint networks to interconnect under various ownership structures. Terms of interconnection are derived for a noncooperative equilibrium. We find that networks mutually profit from interconnection when it creates new services that did not exist beforehand, but also when it creates services that compete directly with existing ones. Given the opportunity to move first, an integrated network will choose not to foreclose its non-integrated rivals. Generally we find that when two or more networks contribute components to a service, double marginalization reduces industry profit and consumer surplus. For this reason, divestiture often harms consumers as well as lowering network profits. Competitive supply of gateway services reduces profit and surplus, but individual networks profit by selling off these facilities to a third party. In contrast, an integrated network will not voluntarily divest its end-to-end service. Compulsory divestiture may inflict serious harm, not only on owners of the integrated network, but on consumers as well.

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Paper provided by EconWPA in its series Industrial Organization with number 9411005.

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Date of creation: 23 Nov 1994
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Handle: RePEc:wpa:wuwpio:9411005
Note: 37pp; postscript file, compressed; keywords: integrated networks, networks
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Avinash Dixit, 1979. "A Model of Duopoly Suggesting a Theory of Entry Barriers," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 20-32, Spring.
  2. Joseph J. Spengler, 1950. "Vertical Integration and Antitrust Policy," Journal of Political Economy, University of Chicago Press, vol. 58, pages 347.
  3. Nirvikar Singh & Xavier Vives, 1984. "Price and Quantity Competition in a Differentiated Duopoly," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 546-554, Winter.
  4. Economides, Nicholas, 1989. "Desirability of Compatibility in the Absence of Network Externalities," American Economic Review, American Economic Association, vol. 79(5), pages 1165-81, December.
  5. Church, Jeffrey & Gandal, Neil, 1992. "Integration, Complementary Products, and Variety," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 1(4), pages 651-75, Winter.
  6. Hugo Sonnenschein, 1968. "The Dual of Duopoly Is Complementary Monopoly: or, Two of Cournot's Theories Are One," Journal of Political Economy, University of Chicago Press, vol. 76, pages 316.
  7. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 105-23, March.
  8. Carmen Matutes & Pierre Regibeau, 1988. ""Mix and Match": Product Compatibility without Network Externalities," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 221-234, Summer.
  9. Bittlingmayer, George, 1990. "Efficiency and entry in a simple airline network," International Journal of Industrial Organization, Elsevier, vol. 8(2), pages 245-257, June.
  10. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
  11. Joskow, P.L., 1989. "Regulatory Failure, Regulatory Reform And Structural Change In The Electric Power Industry," Working papers 516, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Donnenfeld, Shabtai & White, Lawrence J, 1990. "Quality Distortion by a Discriminating Monopolist: Comment," American Economic Review, American Economic Association, vol. 80(4), pages 941-45, September.
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