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08 Interneteconomics Essay

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Internet Economics

John Chuang
School of Information Management & Systems
UC Berkeley
[email protected]

The Big Picture

Structure &


Welfare (surplus)


Producer Surplus
Consumer Surplus
Social Surplus

Why Study Internet
 Internet has interesting economic properties
 Resource allocation
- Rule-based vs. pricing-based

 Market structures
- Interconnections
- Horizontal mergers and vertical integration
- Bandwidth markets

 Policymaking
- Sustainable competition
- Universal access


 Economic characteristics of the Net
 Resource allocation and pricing
 Interconnection and industrial


Economic characteristics of
the Net

Public vs. private good
Economies of scale
Economies of scope
Network externalities


Public vs. Private Goods
 Private good
- depletable and excludable
- e.g., toothpaste, automobile

 Public good
- non-depletable and non-excludable
- e.g., national defense, clean air,

 What about roadways, information,
and the Internet?

Public vs. Private Goods
 Roadways:
- non-depletable (until congestion) and nonexcludable

 Information:
- Encapsulated: depletable and excludable
- Non-encapsulated: non-depletable, but is it

 Internet:
- non-depletable (until congestion), but is it


Economies of scale
 Average cost declines as output level
 Internet exhibits strong economies of scale
 High fixed cost
- e.g., trenching cost, up-front capital investment

 Low/zero marginal cost
- of sending an additional packet


Traditional Goods & Services
 Q* is optimal firm output
 Can support N firms if market
size (QTOT) >= NQ*






Infrastructure Goods &

 High FC, low MC  declining AC
curve (economies of scale)
 Therefore it is socially optimal to
have the entire market served by a
single firm (“natural monopoly”)




 A monopolist:
- is a price-setter, not a price-taker
- maximizes producer surplus (profit), not
consumer surplus

 Alternatives: public utility or regulated
- e.g., AT&T historically treated as regulated
natural monopoly
- rate regulation
- structural regulation


 In a perfect competition:
- all firms are price-takers
- P = MC in the long run
- inefficient firms with high MC will exit
- long term profits = 0
- consumer and total surplus

Technological Change

 Natural monopoly may not last
 Technological change may
result in new cost curve: same
market may now be opti...

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