The Economics of Networks: The "Micro" Approach The Economics of Networks

3.3 The "Micro" Approach

The micro approach starts with an analysis of the specific micro-structure of a network. After identifying the physical aspects of a network, such as nodes and links, we identify the goods and services that are demanded on the network. We distinguish between the case where only end-to-end services are demanded and the case when there is also demand for some services that do not reach from end to end. The case when only end-to-end services exist is easier and has been dealt with in much more detail in the literature. However, many important networks, such as the railroad and telephone networks, provide both end-to-end and partial coverage service. We examine this case later.

We start with a simple case where only end-to-end services are demanded. Suppose that there are two complementary types of goods A, and B. Suppose that each type of good has a number of brands available, Ai, i = 1, ..., m, Bj, j = 1, ..., n, as in Figure 4. Let consumers demand 1:1 combinations AkBj. We call each of the complementary goods Ai or Bj components, while the combined good AiBj is called a composite good or system. Potentially all combinations AiBj, i = 1, ..., m; j = 1, ..., n, are possible. Thus complementarity exists in potential. Complementarity is actualized when the components Ai and Bj are combinable and function together without extra cost, i.e., when the components are compatible. Often it is an explicit decision of the producers of individual components to make their products compatible with those of other producers. Thus, compatibility is a strategic decision and should be analyzed as such.

Modern Industrial Organization provides a rich collection of environments for the analysis of strategic decisions; because of shortage of time and space, this survey will discuss the decision on compatibility only in few environments.

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