Transcript Standard Setting in High

Class 4
GSB 42201: The Legal Infrastructure of
Business
Market Power:
Network Industries
Randal C. Picker
James Parker Hall Distinguished Service Professor of Law
The Law School
The University of Chicago
773.702.0864/[email protected]
Copyright © 2002-14 Randal C. Picker. All Rights Reserved.
Natural Monopoly
Economics
July 17, 2015
2
Natural Monopoly:
Production and Cost
Function


Available to anyone
Given by: cq + K
q
is quantity of good produced
c is the cost of producing one unit of each
good (marginal cost)
K is fixed cost of production
July 17, 2015
3
Natural Monopoly:
Production and Cost
Function
A
producer must pay K regardless of how
much of the good is produced
Think of it as an entry fee to get into the
business
July 17, 2015
4
Understanding Natural
Monopoly


How many firms would an all-powerful
social planner have?
Production Cost Focus: One Firm
Any
quantity of the good can be produced
at the lowest cost by having a single firm
The costs of producing each unit of the
good is the same regardless of the number
of firms (fixed marginal cost of production)
July 17, 2015
5
Understanding Natural
Monopoly
Two
firms = two entry fees (2K) and the
second entry fee is wasted
We might see that this cost function creates
a natural monopoly
July 17, 2015
6
Understanding Natural
Monopoly

Competition Focus: More than One Firm?
Prior
examples make clear that monopolist
will reduce output with deadweight loss
All-powerful social planner needs to control
exercise of monopoly power
Does this through regulation
July 17, 2015
7
Understanding Natural
Monopoly

Natural Monopoly and Regulation
This
production function provides natural
basis for single-firm situations with
regulations controlling exercise of market
power.
July 17, 2015
8
Natural Monopoly and Entry

Entry Questions
Suppose
that we have one firm producing
with this cost function and no regulation.
Will other firms enter?
Put differently, does this production function
give rise to monopoly at all?
July 17, 2015
9
Natural Monopoly and Entry

Answer
It
depends on what the entrant believes will
happen
Three Scenarios
 The
Tough Incumbent
 Price Competition
 Quantity Competition
July 17, 2015
10
No. 1: The Tough
Incumbent

Setup
Entrant
believes that Incumbent monopolist
will slash prices to c, marginal cost, in
response to entry
Will E enter?
July 17, 2015
11
No. 1: The Tough
Incumbent

Answer
No,
just covers marginal costs, and loses
fixed cost of K
July 17, 2015
12
No. 2: Price Competitors

Setup
E
believes and E and I will compete on
price
More precisely, an outcome of their
interaction will be a situation in which E is
happy with her price, given I’s price, and
vice versa.
Will E enter?
July 17, 2015
13
No. 2: Price Competitors

Answer
Probably
not.
Most natural outcome of this process, called
Bertrand competition, is P = c.
Lowering prices slightly diverts the entire
market to the seller and increases profits.
This repeats scenario 1 outcome and no
reason to enter
July 17, 2015
14
No. 3: Quantity Competitors

Setup
Switch
from prices to quantities (Cournot
competition)
Look for an outcome in which E is happy
with her quantity, given I’s quantity, and vice
versa.
Will E enter?
July 17, 2015
15
No. 3: Quantity Competitors

Answer
Specify
demand curve: P = a – bQ
we had P = 10 – Q, so that was a =
10 and b = 1
 Before
End
point: Firms will enter until all profits
are gone (zero profits condition)
July 17, 2015
16
How many?

With cost function and demand curve,
solution has form
N FE
July 17, 2015
a  c  bK

bK
17
How many?

Do the Numbers
a
= 10, b = 1, c = 1
K
= 1 gives N = 8
 K = 9 gives N = 2
 K = 20.25 gives N = 1
July 17, 2015
18
Bottom Line


Duh: Answer depends on precise values
But
Depending
on competition assumptions,
Bertrand v. Cournot, good chance that we
will have more than one firm competing
Remember, this is in a case where the
lowest cost way to produce every quantity
of output is by having a single firm
July 17, 2015
19
Bottom Line
So,
key point, natural monopoly costs will
not necessarily give rise to a monopoly at
all.
July 17, 2015
20
Natural Monopoly
Pricing
July 17, 2015
21
Natural Monopoly: Two Key
Pricing Issues

Above MC Pricing Loses Welfare
Pricing
above marginal costs entails a loss
of welfare. There are consumers who would
be happy to pay more than what it costs to
generate the next unit who will be denied
access to the good.

MC Pricing Causes Insolvency
At
the same time, if price is set at marginal
cost, the firm loses money. It recovers only
the marginal costs of production and does
not recover its fixed costs.
July 17, 2015
22
Ramsey Pricing

Max Welfare Subject to Solvency
The
Ramsey pricing theory looks to set
prices so as to maximize consumer welfare
while ensuring that the firm is just solvent.

Ensuring Fixed Cost Recovery
This
is basically a question of how we price
in the best way while recovering the fixed
costs.
July 17, 2015
23
Ramsey Pricing

Hit the Inelastic
The
basic intuition behind the results is that
you lose less social welfare by trying to
recover the fixed costs from the relatively
inelastic market.
July 17, 2015
24
The Inverse Elasticity Rule

General Ramsey Formula with Linear
Demands
P1  MC1
P2  MC2
1 
2
P1
P2
Where i
is the elasticity of demand for
market I
July 17, 2015
25
The Inverse Elasticity Rule
Elasticity
of demand for a market is the
percentage change in quantity divided by
the percentage change in price for a given
price change

Gap between P and MC is where we
recover fixed costs
July 17, 2015
26
Issues and Limitations


Single-Part Pricing
Information Limitations
Need

lots of info to implement
Technical Limitation
This
version assumes that there is no crosselasticity of demand between the two
markets. (Price in one market does not
effect demand in the second.)
July 17, 2015
27
Issues and Limitations

Fairness Limitations
Individuals
with reduced choices may have
relatively inelastic demands, and they will
get stuck with a disproportionate share of
the fixed costs.
July 17, 2015
28
Two-Part Pricing Hypo

Demand and Cost Functions
We
have fixed costs of a $100,000 and a
constant marginal cost of production of $10.
We have 1,000 consumers with demand
curves of the form P = 50 – 5Q.
July 17, 2015
29
Two-Part Pricing Hypo

Pricing
Set
the price for each unit of the good at
$10.
Charge every consumer a license fee or
membership fee of $100 to buy the good.
This is a separate access charge that is
fixed and it does not vary with quantity
purchased.
July 17, 2015
30
Outcome

What behavior will emerge?
Given
the demand curve, consumers will
purchase the right amount of the good, and
annual cover the fixed costs.

First best solution
That
means that we obtain the maximum
amount of consumer surplus available what
covering the costs of natural monopolist.
July 17, 2015
31
Outcome

Two goods, not one
We
do this by reconceptualizing our single
good as two separate goods. One good is
access or the membership while the second
good in the underlying good itself.
July 17, 2015
32
Outcome


The simple two-part schedule suggested by
Coase achieves the first best outcome.
When we introduce many different types of
consumers, we lose access to the first best
outcome but we can apply our notion of
Ramsey pricing to guide the choice of
prices between access or membership
prices and per unit use prices.
July 17, 2015
33
Standard Setting
July 17, 2015
34
Winner Take All Markets:
Simple Version

Two Sector Economy
500
individuals
One sector: everyone earns $10
Second sector: one person will earn $1000,
everyone else will earn nothing, probability
of winning is just 1/N

What outcome do we want?
July 17, 2015
35
Winner Take All Markets:
Simple Version

Answer
499
in sector 1, 1 in sector 2
GNP is 499 * 10 + 100* 1 = 5990
July 17, 2015
36
Winner Take All Markets:
Simple Version


What outcome will we get?
Answer
Individuals
enter sector 2 until expected
return is $10.
100 individuals in sector 2, 400 in sector 1
GNP is 400 * 10 + 1000*1 + 99*0 = 5000
Same GNP as if we did not have WTA
sector: the value of that sector is fully
dissipated
July 17, 2015
37
SC: DVD Forum
July 17, 2015
38
SC: Outline of License
Program
July 17, 2015
39
SC: DVD 6 Pool
July 17, 2015
40
SC: DVD 6 Pool FAQ 1
July 17, 2015
41
What is the purpose of the
DVD patent pool?



Structure Market
Lower Transaction Costs
Establish Payments to Patent Holders
July 17, 2015
42
DVD Patent Pool: Key
Features

Unification
License
of essential patents by Sony and
Pioneer to Philips.

Essential Patents
Definition
of essential intended to capture
those patents required to enable licensee to
implement DVD-ROM Standard
Specifications.
July 17, 2015
43
DVD Patent Pool: Key
Features

Right to License Outside Pool
Mitigate
potential anti-competitive features
of pool by having individual patent holders
retain the right to license separately.

Grantback
Include
“grantback” provision to bring into
the pool patents later found to be essential
July 17, 2015
44
DVD Patent Pool: Key
Features
This
mitigates the holdout problem posed
by someone later found to hold an essential
patent.
July 17, 2015
45
Lower Transaction Costs

Absent the pool, how would a firm license
the right to make DVDs?
Many
transactions (115 essential patents
for player, 95 for disc)
Risk of Holdout problem
July 17, 2015
46
Lower Transaction Costs

Patent Pool Advantages
Single
Stop Shopping, Sort Of
 Unite
complementary patents into single
package to lower the cost of negotiating
individual licenses.
 But not patents that might be needed as to
which there are substitutes
July 17, 2015
47
Lower Transaction Costs
Mitigate
the threat of infringement litigation
by assembling essential patents.
 Compare
land assembly problem of real
estate developer.
July 17, 2015
48
Payments to Patent Holders


How would patent holders realize value
absent the pool?
How might a pool change the royalty rates
sought by patent holders?
July 17, 2015
49
SEPs and FRANDs
July 17, 2015
50
Technology Competition
and Monopoly
1st Stage
I
Possible Technologies
III
July 17, 2015
II
2nd Stage
SSO
IV
51
Is This a Market Power
Problem? No
I
1st Stage
Possible Technologies
II
2nd Stage
SSO
1. Purpose of patents is to propertize inventions and create
power to exclude (remedy is a different point (see eBay))
2. Market power rules (antitrust and network industries type
regulation) should respect legitimately obtained property
rights, including those that give rise to market power
3. Exercise of market power here through patent shouldn’t
give rise to market power regulation
July 17, 2015
52
Is This a Market Power
Problem? No
III
1st Stage
Possible Technologies
IV
2nd Stage
SSO
1. Should expect first-stage competition to limit harms of ex-post
monopoly created through selection
2. That goes to competing away second-stage monopoly profits
3. Also should expect mechanism to control second-stage price
setting to avoid deadweight losses
July 17, 2015
53
[VITA Home Page]
July 17, 2015
54
[Patent Policy]
July 17, 2015
55
[VITA Patent Process]
July 17, 2015
56
VITA Implements FRAND
“Each WG Member agrees, on behalf of the VITA
July 17, 2015
Member Company he or she represents, that it will
grant to any WG Member, VITA Member
Company, or third party a nonexclusive,
worldwide, nonsublicensable (except to the extent
necessary “to have made”), perpetual patent license
(or equivalent non-assertion covenant) for its
patent claims essential to the Draft VSO
Specification on fair, reasonable and
nondiscriminatory terms to use, make, have made,
market, import, offer to sell, and sell, and to
otherwise directly or indirectly distribute products
57
that implement the Draft VSO Specification.”
Google/Motorola Mobility
July 17, 2015
58
Standard Setting and
Remedies

Setup
Firm
make F/RAND commitment in SSO
process but that leaves open exact
specification of what those royalty rates
would be
Disagreement arises between patent holder
and device producer regarding meaning of
F/RAND
July 17, 2015
59
Standard Setting and
Remedies

Characterizing This?
Breach
of F/RAND commitment by patent
holder?
Infringement by device maker given that the
producer is declining to pay offered royalty?
July 17, 2015
60
Standard Setting and
Remedies

Does the contract matter?
Royalty
Setting Mechanism
 Contract
could specify ADR type mechanism
to resolve disputes over F/RAND
 What if it doesn’t?
July 17, 2015
61
Standard Setting and
Remedies

Does the contract matter?
Scope
of Available Remedies
 Suppose
commitment by patent holder to
SSO includes waiver of right to seek
injunctions for infringement?
 Suppose it doesn’t?
 Which way should the default run on
injunction waiver?
July 17, 2015
62
Standard Setting and
Remedies

Role of the Government?
DOJ
at time of acquisition
Subsequent actions by FTC
 What
role does FTCA Section 5 play in this
process? More broadly, what is the role of
the gov’t here?
July 17, 2015
63
July 17, 2015
64
FTC G/MM (Jan 3, 2013)
July 17, 2015
65
FTC G/MM (Jan 3, 2013)
July 17, 2015
66
FTC G/MM (Jan 3, 2013)
July 17, 2015
67
FTC G/MM (Jan 3, 2013)
July 17, 2015
FTC G/MM: Limits on
68
Pursuing Injunctive Relief
July 17, 2015
FTC G/MM: Limits on
69
Pursuing Injunctive Relief
July 17, 2015
FTC G/MM: Required G
70
Offers and Arbitration
July 17, 2015
FTC G/MM: Required G
71
Offers and Arbitration
Nondiscrimination
Regulation
July 17, 2015
72
July 17, 2015
73
Sandvine Internet Traffic Report 2H 2013
July 17, 2015
74
Sandvine Internet Traffic Report 2H 2013
July 17, 2015
75
FCC: Madison River (Mar 3, 2005)
July 17, 2015
76
FCC: Madison River (Mar 3, 2005)
July 17, 2015
77
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
78
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
79
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
80
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
81
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
82
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
83
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
84
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
85
XFINITY (Comcast) Acceptable Use Policy for Internet
July 17, 2015
86
FCC Comcast Order (Aug 1, 2008)
July 17, 2015
87
FCC Comcast Order
July 17, 2015
88
FCC Comcast Order
July 17, 2015
89
Comcast v. FCC, 600 F.3d 642 (CADC 2010)
July 17, 2015
90
Comcast v. FCC (CADC 2010)
July 17, 2015
91
Comcast v. FCC (CADC 2010)
July 17, 2015
92
FCC Open Internet Rule (Sept 23, 2011)
July 17, 2015
93
FCC OIR: Virtuous Circle of Innovation
July 17, 2015
94
FCC OIR: Transparency
July 17, 2015
FCC OIR: Fixed
95
Broadband: No Blocking
July 17, 2015
FCC OIR: Fixed Broadband: No
96
Unreasonable Discrimination
July 17, 2015
FCC OIR: Metering and
97
Usage Tiers Allowed
July 17, 2015
FCC OIR: Doubts on
98
paid prioritization
July 17, 2015
FCC OIR: Reasonable
99
Network Management
July 17, 2015
FCC OIR: Mobile
100
Broadband: Transparency
July 17, 2015
FCC OIR: Mobile
101
Broadband: Blocking
July 17, 2015
102
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
103
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
104
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
105
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
106
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
107
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
108
Verizon v FCC (CADC, Jan 15, 2014)
July 17, 2015
109
FCC, Open Internet NOPR (May 15, 2014)
July 17, 2015
110
FCC, Open Internet NOPR (May 15, 2014)
July 17, 2015
111
FCC, Open Internet NOPR (May 15, 2014)
July 17, 2015
112
FCC, Open Internet Fact Sheet (May 15, 2014)
July 17, 2015
113
FCC, Open Internet Fact Sheet (May 15, 2014)