Example Pricing Problem

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The cross-network multiplier effect
• of Market 2 on Market 1: 𝛼12 = 1
• of Market 1 on Market 2: 𝛼21 = 5
quantity quantity
Market 1 Market 2
50
q1 = D1 ( p1 ) + 12 D2 ( p2 ) q2 = D2 ( p2 ) + 21D1 ( p1 )

25

5 price 25 price

Final objective of this exercise is to find out

• Which market would you subsidize?
• How much would you lose if you don’t subsidize?
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What would have been the optimal prices in Market
1 and Market 2 if they were independent?

quantity quantity
Market 1 Market 2
50
q1 = D1 ( p1 ) + 12 D2 ( p2 ) q2 = D2 ( p2 ) + 21D1 ( p1 )

25

5 price 25 price
• 𝑝1∗ =?
• 𝑝2∗ =?
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Calculate the increase in demand in Market 1 due to network
(i.e., when demand in Market 2 also drives the demand in
Market 1) at those prices, you derived in the last slide.
qty quantity
Market 1 Market 2
50
q1 = D1 ( p1 ) + 12 D2 ( p2 ) q2 = D2 ( p2 ) + 21D1 ( p1 )

a12= 1
25 a21 = 5

5 price 25
price

Q1 = 25 – 5*2.5 = 12.5 – w/o network effect

Q1 = 25 – 5*2.5 + 1*(50 – 2*12.5) = 37.5 - with network effect
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Calculate increase in revenue in Market 1 due to network

Q1*P1 = 12.5 * 2.5 = 31.25 – w/o network effect

Q1*P1 = 37.5 * 2.5 = 93.75 – with network effect!
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Similarly, calculate the increase in demand in Market
2 due to network
qty quantity
Market 1 Market 2
50
q1 = D1 ( p1 ) + 12 D2 ( p2 ) q2 = D2 ( p2 ) + 21D1 ( p1 )

a12= 1
25 a21 = 5

5 price 25
price

Q2 = ? (w/o network effect)

Q2 = ? (with network effect)
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Similarly, calculate the increase in revenue for
Market 2 due to network

Q2*P2 = ? (w/o network effect)

Q2*P2 = ? (with network effect)
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What is the total revenue from the two markets at
those prices?

Without network effect, Total Revenue

Q1*P1 + Q2*P2 = 31.25 + 312.5 = 343.75

With network effect, Total Revenue

Q1*P1 + Q2*P2 = 93.75 + 1093.75 = 1187.5

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Now consider subsidizing Market 1.
What would be the revenue with network effect if Market 1 price is set at
0, however Market 2 price remains the same as before?

Subsidize Market 1: P1 = 0
Market 2 price remains the same as before: P2 = 12.5

Q1 =
Q2 =

R = P1*Q1 + P2*Q2 = ?

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Now consider subsidizing Market 2.
What would be the revenue with network effect if Market 2 price is set at 0,
however Market 1 price remains the same as before?

Market 1 price remains the same as before: P1 = 2.5

Subsidize Market 2: P2 = 0

Q1 = ?
Q2 = ?

R = P1*Q1 + P2*Q2 = ?

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Can you do better by optimizing the price on Market 2
when Market 1 is subsidized?
How much will you charge in Market 2 and what would be the
total revenue in this case?
Subsidize Market 1: P1 = 0
P2 = ?

Revenue = ?

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Can you do better by optimizing the price on Market 1
when Market 2 is subsidized?

How much will you charge in Market 1 and what would be

the total revenue in this case?

Subsidize Market 2: P2 = 0
P1 = ?

Revenue = ?

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Therefore,

• Which market would you subsidize?

Subsidize Market 1.
• How much would you lose if you don’t subsidize either side and stay with
the original prices?
3828.125 -1187.5 = 2640.625.

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Insights

• Network effects have no impact on pricing strategy when spillover

effects in sales are approximately the same on both sides.

• For additive demand: discount the market with the greater spillover
effect.

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