A discrete model of market interaction in the presence of social networks and price discrimination

Abstract

In this paper, we provide a model to study the equilibrium outcome in a market characterized by the competition between two firms offering horizontally differentiated services, in a context where consumers are the basic unit of decision on the demand side and are related through a social network. In the model, we consider that consumers make optimal choice, participation and consumption decisions, while firms optimally decide their tariffs, eventually using nonlinear pricing schemes. This approach permits us to identify and model two different kinds of network externalities, one associated with tariff-mediated network externalities and the other related to participation network externalities. We apply the model to the telecommunication industry, where we study the impact of alternative regulatory interventions. We provide numerical evidence suggesting that policies designed to reduce horizontal differentiation might be more effective than those designed to limit access charges; this result seems robust to the presence of different forms of price discrimination. We should interpret these findings cautiously due to the existence of potential implementation costs for each policy.