Competition Or Predation? Consumer Coordination, Strategic Pricing And Price Floors In Network Markets

Competition Policy and Antitrust and Networks, the Internet, and Cloud Computing

Article Snapshot


Joseph Farrell and Michael L. Katz


The Journal of Industrial Economics, Vol. 53, No. 2, pp. 203-231, June 2005


This paper looks at how regulation of prices and competition affects consumers of many high-tech products.

Policy Relevance

It will be very hard for competition policy authorities to learn whether a firm’s low prices will harm consumers, especially in markets with network effects.

Main Points

  • Predatory pricing happens when a firm cuts prices so low that rivals go out of business, possibly taking advantage of consumers later.  But this might not be a real danger because competitors return to take advantage of future opportunities, and low prices benefit consumers.

  • “Network effects” mean that consumers value a product more when there are more other users. Computer operating systems tend to be more useful to consumers when there are more other users, because more users attract more developers of applications that work together.

  • Some see more threats to competition when there are network effects, but this will not always happen; when it does, it will be hard for regulators to act without doing harm. A single dominant firm can still benefit consumers because of standardization.

  • Two tests for predatory pricing involve:
    • Checking if a firm’s prices are below its costs. But this can sometimes help consumers and should not always be banned.
    • Checking if a firm’s prices allow it to profit when rivals go out of business (the “Ordover-Willig” rule). This rule is often praised, but can harm consumers even when properly applied.

  • Both tests have problems that make it very hard for regulators to use when there are network effects without harming consumers. Sometimes, having a single dominant firm makes sense.

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