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Negative Network Externalities in Two-Sided Markets: A Competition Approach

Kurucu, Gokce (2007): Negative Network Externalities in Two-Sided Markets: A Competition Approach.

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Abstract

Consider a firm advertising in a job matching agency with the aim of employing the most qualified workers. Its chances of success would be higher for a smaller number of competitor firms advertising in the same job matching agency, i.e. careerbuilder.com. How would the resulting competitive behavior among the firms which are advertising to this job matching agency affect the agency’s optimal pricing behavior? I analyze the optimal market structures and pricing strategies of a monopolist platform in a two-sided market setup in which the agents on each side prefer the platform to be less competitive on their side; that is, a market with negative intra-group network externalities. I find that the equilibrium market structure varies with the extent of negative externalities. If the market’s negative network externalities are substantial, that is, if an agent’s disutility given the size of the agent pool on his side is high (enough), then the profit-maximizing strategy for the matchmaker will be to match the highest types of one side with all of the agents on the other side, by charging a relatively high price from the former side and allowing free entrance for the agents of the latter side. However, if the network externalities on one side are not substantial, then the matchmaker will maximize profits by matching an equal number of agents from each side. This paper thus provides an explanation of the asymmetric pricing schedules in two-sided markets where the matchmaker uses a one-program pricing schedule.

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