Anti-Competitive Interconnections: The Effects of the Elasticity of Consumers' Expectations and the Shape of the Network Effects Function

I find that interconnection might cause the market to be less competitive, and might lead to an increase in the price firms charge for their product. Absent interconnection, firms compete for a consumer for two reasons. The first reason is to obtain revenue from selling the product to a consumer (as in the case without network effects). The second reason is that by expanding the network by one more consumer, the product becomes more attractive to all other consumers. Interconnection eliminates the second reason – when firms interconnect, they are no longer concerned with consumers following the crowd. I show that consumers and society might be worse off from interconnection. I focus on two factors that make the (post-interconnection) price increase larger: consumer expectations that are highly sensitive to prices and consumers putting a high value on small increases in network size at the equilibrium market shares. Both of these factors make firms highly competitive, but only if the firms’ products’ networks are not interconnected.