The Economics of Network Neutrality

Abstract

Pricing of Internet access has been characterized by two properties: Parties are directly billed only by the Internet service provider (ISP) through which they connect to the Internet. Pricing, moreover, is not contingent on the type of content being transmitted. These properties define a regime known as “network neutrality.” In 2005, some large ISPs proposed that application and content providers directly pay them additional fees for accessing the isps’ residential clients, as well as differential fees for prioritizing certain content. We analyze the private and social incentives to introduce such fees when the network is congested and more traffic implies greater delays. We derive conditions under which network neutrality would be welfare superior to any feasible scheme for prioritizing service. Extending our analysis to encompass ISPs’ incentives to invest in more bandwidth, we show that the ability to price discriminate increases their incentives to invest. In terms of overall welfare, we show the additional investment may or may not offset any static inefficiency associated with discrimination.

Keywords: Network Neutrality, Two-Sided Markets, Internet, Monopoly, Price Discrimination, Regulation, Congestion

JEL Classification: L1, D4, L12, L13, C63, D42, D43