South-Westerns' Economic News Summaries
Lining up buyers and sellers can start to look a lot like antitrust activity
Subject Prices in two-sided markets may not reflect production costs much at all.
Topic Profit Maximization and the Firm; Product Markets
Key Words regulation, two-sided markets, price, profits

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Reference ID: A139564647
News Story

Economists and government regulators alike are beginning to look at “two-sided markets:” economists because we don’t understand such markets very well, and regulators because they can begin to look anti-competitive.

Economists understand one-sided markets well. Firms produce to the point where their profits are maximized. The more competitive the market, the lower the markup of price over cost the firm can set. But what happens when a market needs both buyers and sellers to come together? Price may have no reflection on costs of production.

Take cellular service providers. These companies clearly need consumers to have phones; if customers don’t buy phones, they won’t buy cellular service. So the phones are sold cheaply, and the service contracts create the profits for the providers. But it’s more than that. Computer manufacturers, for instance, need people to buy their computer systems so that software designers will want to create games for them. The more systems are sold, the more appealing it looks to create software for the system. The more software that exists for a given system, the more systems will be sold. Which side reaps the benefits, though, and what are the implications of changing price in either of the two markets?

Strange things may happen when prices change. In the computer industry, if the systems begin to fall in price, then firms may no longer want to produce them, which hurts software creators. But if software makers raise their price, it may be the case that both sides of the market will be hurt, since people will stop buying both complementary goods. In short, economists just don’t know the impact of price changes on profitability. That see-saw effect concerns government regulators, because as profits changes, so do the opportunities for market competition.

Questions
1.

How are credit cards an example of a two-sided market?

2. Is it possible that the profit-maximization norm in a one-sided market is no longer valid in a two-sided market? Why or why not?
3. According to the article, why may it be unlikely that firms in a two-sided market will collude?
Source “Matchmakers and trustbusters.” The Economist. 8 December 2005. http://www.economist.com
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