When Does a Platform Create Value by Limiting Choice?

We present a theory for why it might be rational for a platform to limit the number of applications available on it. Our model is based on the observation that even if users prefer application variety, applications often also exhibit direct network effects. When there are direct network effects, users prefer to consume the same applications to benefit from consumption complementarities. We show that the combination of preference for variety and consumption complementarities gives rise to (i) a commons problem (users have an incentive to consume more applications than the social optimum to better satisfy their preference for variety); (ii) an equilibrium selection problem (consumption complementarities often lead to multiple equilibria); and (iii) a coordination problem (lacking perfect foresight, it is unlikely that users will end up buying the same set of applications). The analysis shows that the platform can resolve these problems by limiting the number of applications available. By limiting choice, the platform may create new equilibria (including the socially efficient allocation), destroy Pareto-dominated equilibria, and reduce the severity of the coordination problem faced by users

Mixed Source

We study competitive interaction between profit-maximizing firms that sell software and complementary goods or services. In addition to tactical price competition, we allow firms to compete through business model reconfigurations. We consider three business models: the proprietary model (where all software modules offered by the firm are proprietary), the open source model (where all modules are open source), and the mixed source model (where a few modules are open). When a firm opens one of its modules, users can access and improve the source code. At the same time, however, opening a module sets up an open source (free) competitor. This hampers the firm's ability to capture value. We analyze three competitive situations: monopoly, commercial firm vs. non-profit open source project, and duopoly. We show that: (i ) firms may become 'more closed' in response to competition from an outside open source project; (ii ) firms are more likely to open substitute, rather than complementary, modules to existing open source projects; (iii) when the products of two competing firms are similar in quality, firms differentiate through choosing different business models; and (iv ) low-quality firms are generally more prone to opening some of their technologies than rms with high-quality products

Competing Complements

In Cournot's model of complements, the producers of A and B are both monopolists. This paper extends Cournot's model to allow for competition between complements on one side of the market. Consider two complements, A and B, where the A + B bundle is valuable only when purchased together. Good A is supplied by a monopolist (e.g., Microsoft) and there is competition in the B goods from vertically differentiated suppliers (e.g., Intel and AMD). In this simple game, there may not be a pure-strategy equilibria. In the standard case where marginal costs are weakly positive, there is no pure strategy where the lower quality B firm obtains positive market share. We also consider the case where A has negative marginal costs, as would arise when A can expect to make upgrade sales to an installed base. When profits from the installed base are sufficiently large, a pure strategy equilibrium exists with two B firms active in the market. Although there is competition in the complement market, the monopoly Firm A may earn lower profits in this environment. Consequently, A may prefer to accept lower future profits in order to interact with a monopolist complement in B

A Reference Price Theory of the Endowment Effect Ray Weaver

ABSTRACT Acquiring a good seems to increase its value to the owner, as consumers show reluctance to trade away their possessions for similarly valuable money or other goods. The established explanation for this endowment effect is that consumers evaluate potential trades with respect to their current holdings. From this perspective, selling prices exceed buying prices because owners of a good regard its potential loss to be more significant than non-owners regard its potential acquisition. In contrast to this "pain-of-losing" account, we propose a reference price theory which characterizes the endowment effect as the reluctance to trade on unfavorable terms. In this view, consumers evaluate potential trades with respect to salient reference prices, and selling prices (or trading demands) are elevated whenever the most common reference prices -typically market prices -exceed personal valuations. In seven experiments (and eight more summarized in appendices), we show that manipulations which reduce the gap between valuations and reference prices tend to reduce or eliminate the endowment effect. These results support our theory and suggest that the endowment effect is often best construed as an aversion to bad deals, rather than an aversion to losing possessions. Keywords: Endowment effect, evaluation disparities, reference prices, loss aversion, transaction utility. 2 Buying and selling have a deep symmetry. When an apple is traded for an orange, there is no basis for even distinguishing the "buyer" from the "seller" -these labels can be uniquely assigned only when money is one of the "goods" being exchanged. Since economic theory treats buying and selling symmetrically 1 In practice, they don't. In their review of 59 studies involving ordinary market goods, Horowitz and McConnell (2002) report that selling prices are nearly three times higher than buying prices. In contrast to this "pain-of-losing" account, we propose that the endowment effect is often better understood as the reluctance to trade on unfavorable terms. Consumers evaluate potential trades with respect to salient reference prices, and selling prices (or trading demands) are elevated because the most common reference prices (market prices) typically exceed valuations. In seven experiments, we show that manipulations which reduce the gap between valuations and reference prices tend to reduce or eliminate the endowment effect. These results suggest that the endowment effect is often best construed as an aversion to bad deals, rather than an aversion to losing possessions. VALUATIONS, REFERENCE PRICES AND TRANSACTION DISUTILITY Thaler (1985) proposed that consumers consider not only the benefits from the good they might buy or sell, but also the perceived merits of the deal: whether the actual price is higher or lower than they expect. In one study, participants imagined sitting on a beach with a friend who had just offered to bring them back a bottle of their favorite beer. On average, participants authorized their companion to spend $2.65 when told that beer would be purchased from a fancy hotel, but just$1.50 when it came from a run-down grocery store. In other words, the expectation to pay less became a willingness to pay less. Analogously, participants who contemplated selling tickets to a hockey game they could no longer attend demanded more if the original purchase price was higher. These examples are supported by other research We propose that the endowment effect is due in large part to transaction disutility, which typically acts to increase selling prices (though sometimes acts to reduce buying prices). A simple model will help us state our claim more precisely. Assume that a consumer's desire for any given good can be expressed in monetary terms as his valuation v, which indicates his expected benefits from using the good: his "consumption utility" Although transaction disutility can create price gaps by inflating selling prices or by depressing buying prices, the influence on selling prices is far more common in practice. The reason for this is that market prices, and therefore reference prices, tend to substantially exceed 5 valuations for an arbitrarily selected product (such as a coffee mug).). In other words, most people are typically unwilling to buy most products at their retail prices. 3 As a consequence, transaction disutility tends to distort selling prices upward, while buying prices tend to faithfully reflect valuations. The pain-of-losing account presumes that selling and buying have fundamentally different psychologies: owners are thought to experience the act of selling as "losing" the item being sold, whereas buyers are not seen as experiencing an analogous loss. Tversky and Kahneman (1991, p. 1055), for example, suggest that "the buyers in these transactions do not appear to value the money they give up in a transaction as a loss." By contrast, we propose that there is no inherent difference in the psychology of selling versus buying. Though we also attribute most price gaps to sellers, we believe this is "only" because reference prices tend to exceed valuations. Although both theories explain the endowment effect in terms of loss aversion, they differ with respect to the reference point from which prospective gains and losses are evaluated. According to the pain-of-losing account, the relevant referent is endowment status (whether one currently possesses the good), whereas by our account it is the good's reference price. The idea that reference price comparisons might be involved in the endowment effect has some support in recent research. When studying how consumers justify disparities between buying and selling prices, EXPERIMENTAL TESTS THAT MANIPULATE REFERENCE PRICES Most previous studies on the endowment effect cannot differentiate pain-of-losing and reference price accounts because they involve goods whose reference prices considerably exceed most consumers' valuations. This confounds the effect of endowment (sellers are endowed whereas buyers are not) with the effect of transaction disutility (which in such circumstances affects sellers but not buyers). To differentiate the two accounts, we manipulate both endowment status and reference prices. If the endowment effect is caused primarily by differences in ownership status, reference prices shouldn't matter. But if it is caused primarily by owners' aversion to making bad deals, the effect should shrink when the reference price is reduced to a level closer to typical valuations. Thus, our model makes two predictions: that the gap between buying and selling prices will diminish as a good's reference price is reduced from high to moderate, and that this convergence will be driven by lower selling prices. Manipulations of r over this range should have comparatively little effect on buyers. It is important to clarify that our characterizations of reference prices as "low", "moderate," or "high" are made with respect to the typical consumer's valuation. Although valuations cannot be observed directly, we do observe buying and selling prices and from these can infer the relation between r and v. This inference can be made at the individual level, but we assign general characterizations by using average buying prices across all respondents in a given treatment, as shown below: We stress that although these characterizations are post hoc, as we must observe buying or selling prices to conclusively label r, they are not ad hoc, because the data do not permit arbitrary labels. So while pretests can help verify that a particular reference price has the presumed relation to valuations, they are not required because the experimental data perform the same function. Note also that as long as there is some heterogeneity in consumers' valuations, r ≠ v for some people, indicating the potential for (and expectation of) a gap between buying and selling prices. Thus, we do not generally expect the gap to disappear at any reference price, but if valuations are clustered near a widely adopted reference price, the disparity should be small. Study 1: Candy Method. Participants (N=125) were recruited for laboratory sessions from two universities. The good was a large box of candy of the kind sold at theater concession stands. All our participants first examined four candy options (Raisinets, Milk Duds, Goobers, and Jelly Belly Sours) and indicated their favorite. Then, using a 2×2 between-subjects design, we manipulated whether respondents were endowed with a box of their preferred candy (yes or no), and the reference price we suggested (high or moderate). For the high r condition, which reflected the good's typical consumption context, respondents were told: "As a point of reference, the Harvard Square Theater sells this candy for 4.00 per box." For the moderate r condition, they were told: "As a point of reference, the Target store in Watertown sells this candy for 1.49 per box." Both statements were true. 8 Next we elicited minimum acceptable selling prices from candy owners and maximum buying prices from non-owners, using an incentive-compatible procedure to discourage under-or overbidding Results. As predicted, reducing the reference price reduced the endowment effect. In the high r condition, the average selling price significantly exceeded the average buying price (S = $2.88 vs. B =$1.54, t 62 = 4.05, p = .0001 by a two-tailed test), but in the moderate r condition, the gap was not significant (S = $1.58 vs. B =$1.20, t 59 = 1.53, p > .13); see between subjects design. Here, following a reviewer's suggestion, we manipulated r by varying the sticker price attached to the product, which we affixed with the kind of "pricing gun" commonly used by retailers. For the high r condition, we specified the pencil's actual retail price of 2.29; for moderate r we used 79¢ -much lower, but still a plausible retail price. In the endowed sessions, all participants received pencils which they were told they could keep. In sessions in which participants were not endowed, we passed around samples for inspection which were then collected. This procedure both familiarized participants with the product and exposed them to its reference price. Subjects then privately recorded their reservation prices. After these were collected, we publicly drew a price at random using a "bingo ball" cage which contained balls representing prices from 30¢ to 3.00 in 30¢ increments. (As in the candy study, this range was not revealed.) This "BDM price" determined the actual transaction price for all participants in the session. The full instructions, which borrow in part from 10 Results. The results, summarized i

Group Size and Incentive to Contribute: A Natural Experiment at Chinese Wikipedia

The literature of private provision of public goods suggests that incentive to contribute is inversely related to group size. This paper empirically tests this relationship using field data from Chinese Wikipedia, an online encyclopedia. We exploit an exogenous reduction in group size as a result of the blocking of Wikipedia in mainland China and examine whether individual contributions increase after the block as predicted in the literature. Our result indicates the opposite: individual contribution of unaffected contributors decreases by 42% on average as a result of the block. We attribute the cause to social effects: contributors care about the number of beneficiaries of their contributions. We build a simple model to illustrate how social effects and group size affect individual incentive to contribute. Consistent with our model prediction, we find that the more a contributor values social recognition, the greater the reduction in her contributions after the block. A series of robustness checks appear to support our explanation

Farsighted house allocation

In this note we study von Neumann-Morgenstern farsightedly stable sets for Shapley and Scarf (1974) housing markets. Kawasaki (2008) shows that the set of competitive allocations coincides with the unique von Neumann-Morgenstern stable set based on a farsighted version of antisymmetric weak dominance (cf., Wako, 1999). We demonstrate that the set of competitive allocations also coincides with the unique von Neumann-Morgenstern stable set based on a farsighted version of strong dominance (cf., Roth and Postlewaite, 1977) if no individual is indifferent between his endowment and the endowment of someone else

Competing Complements

In Cournot's model of complements, the producers of A and B are both monopolists. This paper extends Cournot's model to allow for competition between complements on one side of the market. Consider two complements, A and B, where the A + B bundle is valuable only when purchased together. Good A is supplied by a monopolist (e.g., Microsoft) and there is competition in the B goods from vertically differentiated suppliers (e.g., Intel and AMD). In this simple game, there may not be a pure-strategy equilibria. In the standard case where marginal costs are weakly positive, there is no pure strategy where the lower quality B firm obtains positive market share. We also consider the case where A has negative marginal costs, as would arise when A can expect to make upgrade sales to an installed base. When profits from the installed base are sufficiently large, a pure strategy equilibrium exists with two B firms active in the market. Although there is competition in the complement market, the monopoly Firm A may earn lower profits in this environment. Consequently, A may prefer to accept lower future profits in order to interact with a monopolist complement in B

Vertical Integration and Exclusivity in Platform and Two-Sided Markets

This paper develops techniques to analyze the adoption decisions of both consumers and firms for competing platform intermediaries in two-sided markets, and applies the methodology to empirically measure the impact of vertical integration and exclusive contracting in the sixth-generation of the U.S. videogame industry (2000-2005). I first introduce a framework to structurally estimate consumer demand in these types of hardware-software markets which (i) simultaneously analyzes both hardware and software adoption decisions; (ii) accounts for dynamic issues including the selection of heterogenous consumers across platforms, durability of goods, and agents' timing of purchases; and (iii) explicitly provides the marginal contribution of an individual software title to each platform's installed base of users. Demand results show the gains obtained by a platform provider from exclusive access to certain software titles can be large, and failure to account for dynamics, consumer heterogeneity, and multiple hardware purchases significantly biases estimates. I next specify dynamic network formation game to model the adoption decision of hardware platforms by software providers. Counterfactual experiments indicate that vertical integration and exclusivity benefited the smaller entrant platforms and not the dominant incumbent, which stands contrary to the interpretation of exclusivity as primarily a means of foreclosure and entry deterrence

Vertical Integration and Exclusivity in Platform and Two-Sided Markets

This paper develops techniques to analyze the adoption decisions of both consumers and firms for competing platform intermediaries in two-sided markets, and applies the methodology to empirically measure the impact of vertical integration and exclusive contracting in the sixth-generation of the U.S. videogame industry (2000-2005). I first introduce a framework to structurally estimate consumer demand in these types of hardware-software markets which (i) simultaneously analyzes both hardware and software adoption decisions; (ii) accounts for dynamic issues including the selection of heterogenous consumers across platforms, durability of goods, and agents' timing of purchases; and (iii) explicitly provides the marginal contribution of an individual software title to each platform's installed base of users. Demand results show the gains obtained by a platform provider from exclusive access to certain software titles can be large, and failure to account for dynamics, consumer heterogeneity, and multiple hardware purchases significantly biases estimates. I next specify dynamic network formation game to model the adoption decision of hardware platforms by software providers. Counterfactual experiments indicate that vertical integration and exclusivity benefited the smaller entrant platforms and not the dominant incumbent, which stands contrary to the interpretation of exclusivity as primarily a means of foreclosure and entry deterrence

Platform Competition, Compatibility, and Social Efficiency

In their seminal 1985 paper, Katz and Shapiro study systems compatibility in settings with one-sided platforms and direct network externalities. We consider systems compatibility when competing platforms are two-sided and there are indirect network externalities to develop an explanation why markets with two-sided platforms are often characterized by incompatibility with one dominant player who may subsidize access to one side of the market. Specifically, we model competitive interaction between two providers of horizontally differentiated platforms that act as intermediaries between developers of platform-based products (applications) and users of such products. We find that the unique equilibrium under platform compatibility leads to higher profits than the symmetric equilibrium under incompatibility. Notwithstanding, incompatibility naturally gives rise to asymmetric equilibria with a dominant platform that captures all users and earns more than under compatibility. Our model allows a detailed analysis of social efficiency. We find that entry by developers is socially excessive (insufficient) if competing platforms are compatible (incompatible) and that incompatibility generates larger total welfare than compatibility when horizontal differences between platforms are small