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"Investment in Two Sided Markets and the Net Neutrality Debate"
Decision, Risk and Operations Working Papers Series,
Publication type: Working paper
This paper develops a game theoretic model based on a two-sided market framework to investigate net neutrality from a pricing perspective. In particular, we consider investment incentives of Internet Service Providers (ISPs) under both a neutral and non-neutral network regimes. In our model, two interconnected ISPs compete over quality and prices for heterogenous Content Providers (CPs) and heterogeneous consumers. In the neutral regime, connecting to a single ISP allows a CP to gain access to all consumers. Instead, in the non-neutral regime, a CP must pay access fees to each ISP separately to get access to its consumers. Hence, in the non-neutral regime, an ISP has a monopoly over the access to its consumer base. Our results show that ISPs' quality-investment levels are driven by the trade-off they make between softening price competition on the consumer side and increasing revenues extracted from CPs. Specifically, in the non-neutral regime, because it is easier to extract surplus through appropriate CP pricing, ISPs' investment levels are larger. Because CPs' quality is enhanced by ISPs' quality, larger investment levels imply that CPs' profits increase. Similarly, consumer surplus increases as well. Overall, under the assumptions of our model, social welfare is larger in the non-neutral regime. Our results highlight important mechanisms related to ISPs' investments that play a key role in market outcomes, providing useful insights for the net neutrality debate.
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