The correlation of externalities in marginal cost pricing: lessons learned from a real-world case study

Negative externalities cause inefficiencies in the allocation of capacities and resources in a transport system. Marginal social cost pricing allows to correct for these inefficiencies in a simulation environment and to derive real-world policy recommendations. In this context, it has been shown for analytical models considering more than one externality, that the correlation between the externalities needs to be taken into account. Typically, in order to avoid overpricing, this is performed by introducing correction factors which capture the correlation effect. However, the correlation structure between, say, emission and congestion externalities changes for every congested facility over time of day. This makes it close to impossible to calculate the factors analytically for large-scale systems. Hence, this paper presents a simulation-based approach to calculate and internalize the correct dynamic price levels for both externalities simultaneously. For a real-world case study, it is shown that the iterative calculation of prices based on cost estimates from the literature allows to identify the amplitude of the correlation between the two externalities under consideration: for the urban travelers of the case study, emission toll levels—without pricing congestion—turn out to be 4.0% too high in peak hours and 2.8% too high in off-peak hours. In contrary, congestion toll levels—without pricing emissions—are overestimated by 3.0% in peak hours and by 7.2% in off-peak hours. With a joint pricing policy of both externalities, the paper shows that the approach is capable to determine the amplitude of the necessary correction factors for large-scale systems. It also provides the corrected average toll levels per vehicle kilometer for peak and off-peak hours for the case study under consideration: again, for urban travelers, the correct price level for emission and congestion externalities amounts approximately to 38 EURct/km in peak hours and to 30 EURct/km in off-peak hours. These toll levels can be used to derive real-world pricing schemes. Finally, the economic assessment indicators for the joint pricing policy provided in the paper allow to compare other policies to this benchmark state of the transport system

On-Net/Off-Net Price Discrimination and 'Bill-and-Keep' vs. 'Cost-Based' Regulation of Mobile Termination Rates

This paper surveys the recent literature on competition between mobile network operators in the presence of call externalities and network effects. It shows that the regulation of mobile termination rates based on “long-run incremental costs” increases networks’ strategic incentives to inefficiently set high on-net/off-net price differentials, thus harming smaller networks and new entrants. The paper argues in favor of a “bill-and-keep” system for mobile-to-mobile termination, and presents international evidence in support of this conclusion.mobile termination, network effects, call externalities, bill-and-keep

Network Externalities and Critical Mass in the Mobile Telephone Network: a Panel Data Estimation

This paper develops a simple demand model with network externalities which allow us to identify the shape of the network externalities function in the mobile telephone market and to estimate the critical mass. If the mobile telephone network exhibits positive network externalities, we expect that the demand curve is not downward sloping everywhere but it has an increasing part, the critical mass of the installed base of subscribers. Once the critical mass is reached, the growth of the network is self-sustaining. We use a panel data of the 30 OEDC Countries from 1989 to 2006 for estimating the relationship between price of 3-minute cellular call and the installed base of subscribers; we find strong network externalities effects in mobile telephone market which drive the demand curve for this network good to be an inverted U function. Moreover, given that the concavity of the demand curve depends on the extent of network externalities, the idea is to identify some variables which could affect the intensity of network effects in the mobile telephone market, because the more concave the demand curve is, sooner the critical mass is reached for any price. This may have important implications for producers in terms of initial investment and marketing strategies which they have to do to attain the critical mass.Network Externalities, Mobile Telecommunication, Critical Mass

Co-ordination and Lock-in: Competition with Switching Costs and Network Effects

Switching costs and network effects bind customers to vendors if products are incompatible, locking customers or even markets in to early choices. Lock-in hinders customers from changing suppliers in response to (predictable or unpredictable) changes in effciency, and gives vendors lucrative ex post market power-over the same buyer in the case of switching costs (or brand loyalty), or over others with network effects. Firms compete ex ante for this ex post power, using penetration pricing, introductory offers, and price wars. Such "competition for the market" or "life-cycle competition" can adequately replace ordinary compatible competition, and can even be fiercer than compatible competition by weakening differentiation. More often, however, incompatible competition not only involves direct effciency losses but also softens competition and magnifies incumbency advantages. With network effects, established firms have little incentive to offer better deals when buyers’ and complementors’ expectations hinge on non-effciency factors (especially history such as past market shares), and although competition between incompatible networks is initially unstable and sensitive to competitive offers and random events, it later "tips" to monopoly, after which entry is hard, often even too hard given incompatibility. And while switching costs can encourage small-scale entry, they discourage sellers from raiding one another’s existing customers, and s also discourage more aggressive entry. Because of these competitive effects, even ineffcient incompatible competition is often more profitable than compatible competition, especially for dominant rms with installed-base or expectational advantages. Thus firms probably seek incompatibility too often. We therefore favor thoughtfully pro-compatibility public policy.

Network Effects and Switching Costs: two short essays for the new New Palgrave

We briefly survey the economics of network effects and switching costs (in 3,400 words). For comprehensive coverage of the same ground see Farrell and Klemperer’s 60,000-word contemporaneous survey, available at www.paulklemperer.org

Competition Policy In Network Industries: An Introduction

We discuss issues of the application of antitrust law and regulatory rules to network industries. In assessing the application of antitrust in network industries, we analyze a number of relevant features of network industries and the way in which antitrust law and regulatory rules can affect them. These relevant features include (among others) network effects, market structure, market share and profits inequality, choice of technical standards, relationship between the number of active firms and social benefits, existence of market power, leveraging of market power in complementary markets, and innovation races. We find that there are often significant differences on the effects of application of antitrust law in network and non-network industries.networks, network effects, public policy, antitrust, telecommunications, technical standards

Competition Policy in Network Industries: An Introduction

The author discusses issues of the application of antitrust law and regulatory rules to network industries. In assessing the application of antitrust in network industries, we analyze a number of relevant features of network industries and the way in which antitrust law and regulatory rules can affect them. These relevant features include (among others) network effects, market structure, market share and profits inequality, choice of technical standards, relationship between the number of active firms and social benefits, existence of market power, leveraging of market power in complementary markets, and innovation races. The author finds that there are often significant differences on the effects of application of antitrust law in network and non-network industries.