The Economics of Networks: Interview with N. Economides
Part 3

Intro | Part 1: On Networks | Part 2: On Networked Industries and Market Structure | Part 3: On Policy and Microsoft

On Policy
 

Q:	What challenges do network industries raise for public policy?

 
Network industries have features I discussed above that should be taken into account in giving public policy advice. Also, the economic analysis of networks is a relatively new field in economics, and I do not think economists have an all-encompassing analysis of the field.

The goal of public policy should be to maximize economic efficiency. Economic efficiency has three components: (i) allocative efficiency; (ii) productive efficiency; and (iii) dynamic efficiency. To maximize allocative efficiency, goods must be sold at prices close to cost. To maximize productive efficiency, goods should be produced in the most efficient way possible. To maximize dynamic efficiency, the industry must maximize innovation and growth. In general, these objectives may be in conflict, and there may not exist a policy that maximizes all of them.

Like for any other industry, there is a need of a deep understanding of the particular network industry before offering policy advice or imposing rules and regulations. This is especially important because many network industries, including the computer industry, exhibit high growth. Elementary or static models of economic analysis may miss the essence of the market and lead to social losses.
 
 

Q:	How active should the government be in following these policies?

 
The government should intervene when there are clear violations of the antitrust law. The government should also be relatively cautious, taking into account that economists do not yet have an all-encompassing analysis of the field.
 

On Microsoft
 

Q:	You have been following the details of the Microsoft case on part of your website. Do you have any predictions you'd like to share?

 
A full answer to your question will take many pages of analysis. I will only say briefly (and enigmatically) that I do not expect the outcome of the present case against Microsoft to result in any significant change in the market structure in the OS market and other software markets.
 
 

Q:	You argue in a recent paper that a monopolist has incentives to raise the costs of rivals in complementary markets and that Microsoft may have done this by bundling IE4 with Windows operating systems. Can you explain the motivation for this action and the social welfare consequences?

 
A firm that monopolizes an essential input and also produces a complementary good has an incentive to raise the costs of rivals in the complementary good market. For example, a local telephone company, such as Bell Atlantic has an incentive to raise the costs of a long distance company, such as AT&T, once Bell Atlantic is allowed to provide long distance services. Microsoft has similar incentives, i.e., to raise the costs of applications rivals. But there is also a significant difference between the case of a local telephone company and Microsoft in the extent of their ability to increase rivals' costs. There are presently no alternatives to telephone access at home except through the local telephone company, which can raise the costs of long distance or local rivals to the extent it wants. On the other hand, Microsoft has a long run commitment to an open system. When independent software providers write applications for Windows, the value of Microsoft's operating system increases. Thus, Microsoft discloses hooks (APIs) that allow the independent programs to run under Windows. Thus, there are market substitutes for key Windows OS functions. For example, Symantec sells a replacement for Windows Explorer and Desktop. Because of the existence of such substitutes, the extent to which Microsoft can increase browser rivals' costs is limited.
 
 

Q:	The Microsoft case has received a considerable amount of attention in the press recently. Are there any common misconceptions about the economics of the Microsoft case?

 
A common misconception is that "path dependence" and "history" determines everything. Even when history plays a big role, companies have the opportunity to determine their fate by using pricing policies. If everything were determined by path dependence and history, Apple would be where Microsoft is today, in terms of market share in the OS system market. Apple made huge and repeated errors in its decisions on pricing and compatibility, resulting in its present marginal position in the industry.

A second type of common misconceptions arises from isolating a particular fact or a particular statistic from the OS market without checking for consistency with other facts. Economic behavior has to be consistent and make sense in the context of the present market structure and the objectives of the players. Journalists expect consistency in mathematics and physics but hardly require it in economics. For example, it is not sufficient to note the large market share of Windows. One has to also offer an explanation for the relatively low price of Windows, and this explanation has to be consistent with the observed high market share of Windows.

A third type of misconception arises out of lack of understanding of basic economics and basic antitrust law. For example, the fact that the Stern School of Business has a monopoly (100% market share) in Stern MBA degrees hardly gives Stern monopoly power in the MBA market in the eyes of economists or in terms of antitrust law. Why? Because there are close substitutes, i.e., MBA degrees from Columbia, Harvard, MIT, etc. Economic and legal determination of anti-competitive conditions and actions requires a deeper examination of the industry.

More links

• For more sources of information on the Network Externalities see my past feature on Network Externalities.
• Professor Economides maintains web sites on the Economics of Networks and on the current Microsoft Legal Battle.
• You can contact Economides via email at neconomi@stern.nyu.edu or visit his Home Page.

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