Information Technology

Information Technology - Information Technology...

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Information Technology COMPLEMENTARITY AND NETWORK EXTERNALITY Definition: Commodity A complements commodity B if more of commodity A increases the value of an extra unit of commodity B. More software increases the value of a computer More roads increase the value of a car Definition: A commodity has a positive network externality if the utility to a consumer of that commodity increases as more people also consume the commodity. Email gives more utility to any one user if more other people use email A highway gives less utility to any one user as more people use it (negative network externality, also known as congestion effect) PRICING OF COMPLEMENTARY PRODUCTS Information technologies have increased greatly the complementarities between commodities. Computers and operating systems DVD players and DVD disks WiFi sites and laptop computers Cell phones and cell phone towers How should a firm behave when it produces a commodity that complements another commodity? The problem is: When you make more of your product (commodity A) you increase the value of firm B's product (commodity B). Can you get for yourself some of the gain you create for firm B? An obvious strategy is for firms A and B to cooperate somewhat with each other. Microsoft releases part of its OS to firms making software that runs under its OS DVD manufacturers agree upon a standard format for their disks Suppose the price of a computer is p c . The price of the OS is p os . The quantities demanded of computers and the OS depend upon p c + p os , not
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just p c or just p os . Suppose the computer and software firms' marginal production costs are zero. Fixed costs are F c and F os . Suppose the firms do not collude. The computer firm's problem is: choose p c to maximize p c D(p c + p os ) - F c The OS firm's problem is: choose p os to maximize p os D(p c + p os ) - F os Assume D(p c + p os ) = a - b(p c + p os ). The computer firm's problem is: choose p c to maximize p c (a - b(p c + p os )) - F c The OS firm's problem is: choose p os to maximize p os (a - b(p c + p os )) - F os The first-order conditions imply: p c = (a - b p os ) / 2b. ---(C) p os = (a - b p c ) / 2b. ---(OS) A Nash equilibrium is a pair (p
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This note was uploaded on 09/06/2010 for the course FBE ECON2113 taught by Professor Franchsica during the Fall '09 term at HKU.

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Information Technology - Information Technology...

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