A Study On The Dynamic Efficiency Of Network Competition

Some industries need physical or virtual networks to provide their products and services. In economics we call them network industries. Dynamic efficiency of competition is rather important in those industries. Regulation of network industries should not only aim at insuring that today's consumers face a broad variety of products at competitive prices but also aim to insure that future consumers will be served properly.This paper first examines the features of network competition and various meanings of dynamic efficiency using industrial organization theory. Then we review the literature of network competition and dynamic efficiency. At last we develop a network competition model with investment and network externalities, using the telecommunication industry as an example. We use Ramsey sub-optimum as the social welfare benchmark, in which the price structure stands for static efficiency and investment level stands for dynamic efficiency. We examine these two efficiencies under competitive equilibrium and the influence of access pricing rule as well as network externality intensity and network substitutability. Our findings indicate that, there exists an "ideal equilibrium state", in which competitive equilibriums could provide enough innovations without loss of static welfare of consumers. In this situation network externalities are just intensive enough to offset the negative externalities of quality investment. Thus industry profit is positive while both consumer and operator welfare reach social optimum. Static efficiency and dynamic efficiency no longer conflicts with each other. On the contrary they could be gained simultaneously. What the regulators need to do in this situation is merely to set access charge at cost. However the restrictions on "ideal equilibrium state" are rarely satisfied in many network industries. Then the regulators have to balance between static efficiency and dynamic efficiency and use well-designed regulation policies to ensure that the industries reach "sub-optimal equilibrium state" area. In a word, this paper combines two different sources of literature, i.e. network competition and network externalities. We develop a canonical model to study static and dynamic efficiency. Thus, this paper contributes some findings to the result of relative literature.