Insulated Platform Competition

Abstract:     
The externalities advertisers receive from newspaper readers and that operating system users receive from software developers are among the leading features of those industries. However, such externalities create indeterminacies in both supply and demand that have rendered intractable the analysis of rich, policy-relevant models that take these features into account. In this paper, we propose a static solution concept for platform competition, Insulated Equilibrium (IE), that resolves these indeterminacies.

Under IE, firms charge prices that are low when they have fewer than their targeted number of consumers, solving consumer coordination problems and leading to intuitive predictions of platforms' prices. We show that consumption externalities create a distortion that is analogous to the one arising in Spence’s (1975) model of a quality-choosing monopolist. Furthermore, the effect that competition has on this distortion depends on whether platforms are primarily differentiated by the degree of externalities they generate or along some other dimension.

Number of Pages in PDF File: 38

Keywords: Two-Sided Markets, Multi-Sided Platforms, Oligopoly, Insulated Equilibrium, Antitrust and Mergers in Network Industries

JEL Classification: D21, D43, D85, L13

working papers series