Review of Network Economics

Compatibility with Firm Dominance

María Fernanda Viecens — Tue, 06 Dec 2011 17:47:17 PST

This paper considers the effect of compatibility decisions on consumers and welfare in a setting where the platforms are asymmetric and consumers have to decide both which platform to join and which applications to buy that run on these platforms. The paper shows that imposing a higher degree of application compatibility, when applications are close substitutes, may lower social welfare. Application compatibility is compared with platform compatibility and the results indicate that the two types of compatibility have opposite implications for how firms and consumers are affected by compatibility. Finally, it is shown that a policy of application compatibility that increases static efficiency can have adverse effects on dynamic efficiency.

Margin Squeeze in Fixed-Network Telephony Markets — Competitive or Anticompetitive?

Wolfgang Briglauer et al. — Tue, 06 Dec 2011 17:47:15 PST

This paper looks at the effects of different forms of wholesale and retail regulation on retail competition in fixed network telephony markets. We explicitly model two asymmetries between the incumbent operator and a group of homogenous entrants: (i) while the incumbent has zero marginal costs, the entrant has the wholesale access charge as (positive) marginal costs; (ii) while the incumbent sets a two-part tariff at the retail level (fixed fee and calls price), the entrant can only set a linear price for calls. We model the product of the incumbent as horizontally differentiated from the products of the entrants, who are homogenous and do not have any market power. Competition from other infrastructures such as mobile telephony or cable is modelled as an “outside opportunity” for consumers. We find that entrants without market power might be subject to a margin squeeze if the wholesale access price is set at average costs and competitive pressure from other infrastructures increases. We argue that wholesale price regulation at average costs is not optimal in such a situation and discuss other forms of cost-based regulation, retail-minus and deregulation as potential alternatives.

Power Transmission Network Investment as an Anticipation Problem

Vincent Rious et al. — Tue, 06 Dec 2011 17:47:13 PST

Power generation and transmission are complementary activities that must be coordinated to ensure an optimal use and development of the transmission network. This coordination is today more difficult in a liberalized system, because of unbundling and the freedom for investors to choose their generation technologies (Joskow, 2006). Shorter investment time between generation and network create uncertainty for the network planning and congestions. In the economic literature, the efficiency of anticipating generation investment has been under-evaluated assuming that it is a cost free activity. Our model evaluates the effect of anticipation costs and defines in which cases the previous results by Sauma and Oren (2006, 2007) could still hold.

Why is Platform Pricing Generally Highly Skewed?

Richard Schmalensee — Tue, 06 Dec 2011 17:47:10 PST

Bolt and Tieman (2008) suggested the prevalence of profit function non-concavity may account for the widespread use of skewed pricing by two-sided platform businesses. In both the Rochet-Tirole (2003) and Armstrong (2006) models, however, skewed pricing may simply reflect substantial differences between side-specific demand functions; non-concavity is not necessary. In the Rochet-Tirole (2003) model, ubiquitous high pass-through rates, which seem implausible, are required for non-concavity to be prevalent. In the Armstrong (2006) model, non-concavity is not sufficient for skewed pricing. In both models, non-concavity is associated with strong indirect network effects; in the Armstrong (2006) model, such effects are also associated with dynamic instability.

Letter Traffic Demand in the UK: An Analysis by Product and Envelope Content Type

Leticia Veruete-McKay et al. — Mon, 12 Sep 2011 14:35:09 PDT

National postal operators offer a range of mail products to customers. It is likely that demand elasticities for these products differ across both service types and their requirements for sending mail. This paper examines time series data for addressed inland mail in the UK for three broad product categories of mail in order to identify the key drivers of the demand for letter traffic and letter substitution. For the first time, total addressed inland mail in the UK was segmented into mail content categories and preliminary estimates for the drivers of UK letter mail substitution for social, transactional and direct mail are provided.

The Effect of Unobserved Heterogeneity in Stochastic Frontier Estimation: Comparison of Cross Section and Panel with Simulated Data for the Postal Sector

Catherine Cazals et al. — Mon, 12 Sep 2011 14:35:05 PDT

In this paper, we examine the application of SFA method with time-invariant inefficiency and assess its estimation of inefficiency when applied to cross section and panel data. By using simulation methods, we look at the effect of unobserved heterogeneity on the estimates of inefficiency in both cross section and panel. In the presence of unobserved heterogeneity and significant variance in the inefficiency term, stochastic frontier estimation of inefficiency can be significantly different in panel and in cross section. This finding accords with analysis of actual data from the postal sector. We then suggest an estimation method for cost frontier when inefficiency is time-invariant and with unobserved heterogeneity.

The Universal Postal Service after the Lisbon Treaty: a True Step Forward?

Alessandra Fratini — Mon, 12 Sep 2011 14:35:03 PDT

The article analyses the impact of the Lisbon Treaty, entered into force in December 2009, on the provision of postal services and especially on universal services obligations. Through the amendment of the Treaty on European Union and the Treaty on the Functioning of the European Union, the Lisbon Treaty consolidates and develops the established principles of EU law, modifies the institutional structure and decision-making process of the EU, and introduces new services of general interest-related provisions in EU primary law. However, will such modifications effectively have an impact on the provision of postal services, and/or on universal postal services?

What is an Unfair Burden? Compensating the Net Cost of Universal Service Provision

Christian Jaag — Mon, 12 Sep 2011 14:35:00 PDT

This paper discusses the net cost of universal service obligations and the potential burden they represent on the universal service provider. Specifically, it analyzes the situation in the postal sector after full liberalization. It considers various interpretations of what an unfair burden might be and discusses the competitive impact of corresponding compensation scenarios by means of a stylized theoretical model with endogenous entry and coverage decisions.

Universal Service Financing in Competitive Postal Markets: One Size Does Not Fit All

Axel Gautier et al. — Mon, 12 Sep 2011 14:34:58 PDT

In the postal sector, the financial burden of the universal service depends on its content, the postal market characteristics and the country’s geographical configuration. These three groups of factors affect both the direct cost of providing the service and the extent of competition on the market. In this paper, we consider countries with different geographical characteristics and we show that the choice of an appropriate mechanism to share the burden of universal service between market participants depends on the country configuration. Thus, for universal service financing, one size does not fit all.

Environmental Cost and Universal Service Obligations in the Postal Sector

François Boldron et al. — Mon, 12 Sep 2011 14:34:52 PDT

This paper studies the relationship between USO and environmental concern in the postal sector. We concentrate on the obligation to deliver mail on a D+1 basis. We examine how the USO should be designed to properly account for the environmental cost in a variety of situations ranging from a first-best setting to a (Ramsey-type) second-best world with differentiated or uniform prices. We show that, it may be desirable to scale down the D+1 obligation and to restrict it to specific geographic areas. We also study how postal products should be priced to account for their environmental impact.

Welfare and Pricing of Mail in a Communications Market

Philippe De Donder et al. — Mon, 12 Sep 2011 14:34:47 PDT

We build a model where a postal incumbent offering single piece, transactional and advertising mail competes with postal entrants and with a firm offering an alternative medium. We solve for the optimal prices under various competition assumptions. We calibrate the model and provide numerical simulations in order to shed light on the impact of these assumptions on volumes and welfare levels.

The Effect of Flexible Pricing on Entry into the U.S. Letter Market

Robert Cohen et al. — Mon, 12 Sep 2011 14:34:44 PDT

This paper investigates the hypothesis that if the incumbent were given the freedom to adjust its prices for contestable mail, an entrant would be able to capture only a very limited amount of mail and the monopoly would be shown to have little value. It examines the effect of flexible pricing on efficient and inefficient entry into the U.S. letter delivery market. The entrant’s frequency of delivery and the amount of contestable mail in the market appear to be the most important variables (that we have modeled) in determining the success of the entrant. Consequently, the paper develops the sensitivity of the incumbent’s loss of profits to both variables.

Postal Service Pricing Incentives Following the Introduction of Price Cap Regulation

John Panzar — Mon, 12 Sep 2011 14:34:41 PDT

This paper analyzes the pricing incentives facing the U.S. Postal Service due to the change from the Cost of Service Regulation practiced under the Postal Reform Act (PRA) to the Price Cap Regulation required by the Postal Accountability and Enhancement Act (PAEA).

Competition, Pricing and Universal Service in the Postal Sector: An Introduction

Helmuth Cremer et al. — Mon, 12 Sep 2011 14:34:37 PDT

We provide a brief introduction to the current issue of the Review of Network Economics, which is a special issue devoted to the postal sector based on the sixth bi-annual Toulouse conference on “Competition and universal service in the postal sector.”

Card Acceptance and Surcharging: the Role of Costs and Competition

Nicole Jonker — Tue, 07 Jun 2011 18:26:38 PDT

The payment cards market is a two-sided market. Cost sensitivity of both consumers and merchants for card services influences total demand. Survey data of Dutch merchants shows that costs and cost perception affect acceptance as well as surcharging decisions. Merchants who find payment cards expensive are less likely to accept them and more likely to surcharge their customers for using them. Merchants who face any competition accept debit card payments relatively more often than merchants with monopoly power, and they are less likely to surcharge their customers for debit card usage. Intense competition leads to higher credit card acceptance.

ATM Direct Charging Reform: the Effect of Independent Deployers on Welfare

Jocelyn Donze et al. — Tue, 07 Jun 2011 18:26:35 PDT

In Australia, interchange fees on shared ATM transactions have been recently removed and replaced by usage fees directly set and received by ATM owners. We develop a model to study how entry of independent ATM deployers (IADs) affects welfare under the “direct charging scheme.” We show that paradoxically, IAD entry benefits banks. Entry benefits consumers when they strongly value the associated growth of the ATM network.

On the Relationship Between Historic Cost, Forward Looking Cost and Long Run Marginal Cost

William P. Rogerson — Tue, 07 Jun 2011 18:26:32 PDT

This paper considers a simple model where a regulated firm must make sunk investments in long-lived assets in order to produce output, assets exhibit a known but arbitrary pattern of depreciation, there are constant returns to scale within each period, and the replacement cost of assets is weakly falling over time due to technological progress. It is shown that a simple formula can be used to calculate the long run marginal cost of production each period and that the firm breaks even if prices are set equal to long run marginal cost. Furthermore, the formula for calculating long run marginal cost can be interpreted as a formula for calculating forward looking cost (where the current cost of using assets is based on the current replacement cost of assets). However, through appropriate choice of the accounting depreciation rule, it can also be interpreted as a formula for calculating historic cost (where the current cost of using assets is based on the historic purchase cost of assets). In particular, the results derived in the simple benchmark model of this paper contradict the commonly expressed view that measures of forward looking cost are superior to measures of historic cost in environments with declining asset prices.

Strong Ties in a Small World

Marco van der Leij et al. — Tue, 07 Jun 2011 18:26:28 PDT

This paper examines the celebrated “strength of weak ties” theory of Granovetter (1973). We examine two hypotheses implied by the theory: one, for any three players with two links present, the probability of a third link being present is increasing in the strength of the two ties, and two, the removal of a weak tie breaks more shortest paths than the removal of a strong tie. This paper tests these hypotheses using data on co-authorship among economists. Our data supports the hypothesis of transitivity of strong ties, but it rejects the hypothesis that weak ties are more crucial than strong ties. We then propose an explanation for the strength of strong ties which builds on two properties of the network: one, significant inequality in the distribution of connections across individuals, and two, stronger ties among highly connected individuals.

Entry Deterrence and the Calculation of the Net Cost of Universal Service Obligations

Christian Jaag — Wed, 02 Mar 2011 16:10:53 PST

This paper relates to the current discussion about how to measure the net cost and the unfair burden of universal service provision in network industries. The established profitability cost approach compares the profit of a universal service provider (USP) with and without a universal service obligation (USO). This paper argues that the net cost of universal service provision critically depends on the regulatory counterfactual and hence the USP’s strategy space without USO. On the one hand, a strong USO limits the USP’s means to position itself in the market, which offers cream-skimming opportunities and invites competition. On the other hand, a simple game-theoretic entry analysis shows that the USO may effectively serve as a valuable strategic commitment device to deter entry. Hence, the USO may be valuable to the USP despite causing inefficient operations. From a policy perspective, this constitutes a counter-intuitive result for the definition of the USO: the stricter it is regulated, the more detrimental it may be to competition and, therefore, the smaller is its burden on the USP.

Twitter Adoption in Congress

Feng Chi et al. — Wed, 02 Mar 2011 16:10:46 PST

We study the early adoption of Twitter in the 111^th House of Representatives. Our main objective is to determine whether successes of past adopters have the tendency to speed up Twitter adoption, where past success is defined as the average followers per Tweet — a common measure of “Twitter success” — among all prior adopters. The data suggests that accelerated adoption can be associated with favorable past outcomes: increasing the average number of followers per Tweet among past adopters by a standard deviation (of eight followers per Tweet) accelerates the adoption time by about 112 days. This acceleration effect is weaker for those who already have adopted Facebook and those who have access to information about a large number of past adopters. We later find a positive relationship between an adopter's own success and the success of adopters preceding him/her. Thus, there may exist benefits associated with adopting Twitter based on past successes of others. In general, the patterns we find are consistent with predictions generated by a simple model of adoption delay with learning.