The competitive and welfare effects of long-term contracts with network externalities and bounded rationality

Abstract

This paper compares the long-term and short-term contracts in terms of their competitive and welfare effects in a dynamic nonlinear pricing model with network externalities and bounded rationality. Contrary to the existing literature and traditional treatments adopted by competition authorities, we find that a long-term contract is at least as competition-friendly and socially efficient as a sequence of short-term contracts. If the consumers have constant types and pessimistic expectation regarding the network size, then for a certain range of parameters, a long-term contract facilitates entry of more efficient competitors and is socially more efficient than the short-term contracts. If the consumers’ types are independent across time, a long-term contract leads to the same competitive outcome as, but gives a higher social surplus than, its short-term counterpart.