Economics and the Network Neutrality Debate

THE ECONOMICS OF PRODUCTION-LINE RESTRICTIONS WITH AN APPLICATION TO THE NETWORK NEUTRALITY DEBATE
[SOURCE: eScholarship Depository, AUTHOR: Benjamin E. Hermalin and Michael L. Katz]
The University of Berkeley professors examine the welfare effects of product-line restrictions, such as those called for by some proponents of network neutrality regulation. They find that restricting a monopoly supplier to a single product has the following effects: a) consumers who would otherwise have consumed a low-quality variant are excluded from the market; b) consumers "in the middle" of the market consume a higher and more efficient quality; and c) consumers at the top of the market consume a lower and less efficient quality. Total surplus may rise or fall. The authors also examine a duopoly model and find that imposition of a single-product restriction always reduces welfare. Absent the restriction, the two firms engage in head-to-head competition across full product lines. In some circumstances, the restriction induces the two firms to offer identical products. The resulting loss of variety reduces welfare. In other circumstances, the restriction induces the firms to offer non-overlapping, or vertically differentiated, products. Here, the resulting loss of competition harms both consumers and economic efficiency. Lastly, they find that, to the extent that the regulation is intended to eliminate low-quality products, it may fail. Even though any one firm can offer only a single product, various firms can collectively offer a menu of products.
http://repositories.cdlib.org/iber/cpc/CPC06-059/