free internet access: when is it suitable?

INFORMATION

Information Economics and Policy 17 (2005) 302–316

www.elsevier.com/locate/iep

ECONOMICSAND POLICY

Free Internet access: When is it suitable?

Marco Fioramanti *

Institute for Studies and Economic Analysis, P.za dell�Indipendenza 4, 00185 Roma, Italy

Received 17 December 2002; received in revised form 27 July 2004; accepted 27 July 2004

Available online 13 October 2004

Abstract

Since 1998 an increasing number of European Internet Service Providers (ISP) have been

offering Internet access freely. In 2001, the most of ISPs offered free Internet access. Why does

a profit maximizing operator adopts this pricing policy? A consumer who wants to surf on the

Net needs to buy two services: the access from the ISP and the connection from the Telephone

Operator. Since the two services are complementary, the price of one service creates a negative

externality on the demand for the other one. One way to remove this externality is by writing a

contract in which one of the two operators offers an amount of money to the other one, if the

latter fixes his price to zero. In this paper, we show that, under particular conditions on Inter-

net market development, the contractual solution is better than the independent one in which

both operators set their prices independently, without taking into account the negative exter-

nality effect.

JEL classification: L11; L12; L22; L86

Keywords: Internet pricing; Two-part tariff; Monopoly; Complementary services; Double marginalization

1. Introduction

Since 1998 an increasing number of European Internet Service Providers (ISP)

have been offering their service – the access to the global network for consumers

doi:10.1016/j.infoecopol.2004.07.001

* Tel.: +39 6 444 82715; fax: +39 6 444 822249.

E-mail address: m.fioramanti@isae.it.

M. Fioramanti / Information Economics and Policy 17 (2005) 302–316 303

through their hardware and software technologies – free of charge. Why does a profit

maximizing operator practise this pricing policy? This behaviour is sensible because

the Telephone Operator (TO) gives part of his revenue, coming from clients� calls tothe ISP�s Point of Presence (PoP), to the latter.

The theoretical background for free access lies in the fact that, when a consumerwants to surf on the Net, he must pay a two-part tariff t + pxi, where t is the fixed part

paid for the access service to the ISP, and p is the quantity-dependent (xi) part the TO

receives for the connection service between the consumer and the ISP�s PoP. Since thetwo services are complementary, the price of the former limits the demand for the

latter. This paper investigates if there are some ways to eliminate this negative

externality.

Haan (2001) shows that, in a two sided monopoly with predetermined demand in

which both the ISP and the TO fix their prices proportionally to the quantity, thefree-access equilibrium could emerge. The game scheme is a price competition �a la

Stackelberg, where the TO is the leader and the ISP is the follower. In such a game,

the TO offers a ‘‘take-it-or-leave-it’’ lump-sum contract to the ISP if the latter sets his

price – the access price – to zero. At the same time, the TO sets the connection price

in order to maximize his modified profit function, that accounts for the lump-sum

disbursement. If the TO might commit himself to a credible pricing policy, then

the best response for the ISP is to accept the contract. The total profit in the contrac-

tual equilibrium is higher than in the independent solution, both TO and consumersare better off, while the ISP is worse off. The improvement of consumers� welfare is

due to the elimination of what Tirole (1998) 1 calls double marginalization problem.

In a bilateral monopoly, when both monopolists set their own prices without consid-

ering other agents reaction, the final price is higher than the price set by an integrated

monopolist and total profits are lower. To explain why free access did not emerge

immediately, Haan introduces a fixed cost to contract for the TO. In the presence

of this kind of costs, free access only emerges when the Internet market reaches a

critical size, which is function of those costs. Free access emerges even if the TO can-not commit himself in advance to some price p, that is even if the monopolists com-

pete �a la Bertrand. Furthermore, the paper examines the extensions in which: (i) the

market for access is an oligopoly; (ii) the TO is a regulated monopolist; (iii) the TO is

active in the regular telephony market as well. In all these cases, free access could

emerge, although in the latter there are some discontinuities in the equilibria.

MacKie-Mason and Varian (1995) adopt a nearest to reality pricing scheme – a

two-part tariff – even though their goal is to obtain a price that could prevent the

congestion problem. In their model ISP and TO are integrated, and the demand isequal to the total demand coming from a set of heterogeneous consumers. The

authors show that a two-part tariff – consisting of a fixed part to cover the fixed costs

and a variable one proportional to the social cost of congestion, achieved by decen-

tralized maximization of a profit function containing the congestion cost – is optimal

from the social welfare point of view.

1 See p. 174.

304 M. Fioramanti / Information Economics and Policy 17 (2005) 302–316

Following Haan (2001), the aim of this paper is to show under which condition

free access is the best policy for all. However, while Haan provides a solution to dou-

ble marginalization in a model with homogeneous consumers and two monopolists

who set both the prices proportional to the demand, here the model is extended to

include heterogeneous consumer and two monopolists who adopt a different tariffpolicy. The TO sets a price proportional to the quantity of information, while the

ISP sets a fixed fee for each consumer who wants to have access to the Internet. This

scheme reflects the pricing policy which is adopted by TO and ISP in the real world.

Besides, this is coherent (even though in a simplified form) with the operators� coststructure: the TO�s costs are proportional to the bandwidth (the information ex-

changed by each consumer), while the ISP� costs are proportional to the number

of clients.

In this model there are three subsets of agents:

� a set of heterogeneous consumers;

� the Telephone Operator (TO);

� the Internet Services Provider (ISP).

The consumers demand both complementary goods, the access and the connec-

tion, to the ISP and the TO, respectively. These two operators are monopolists in

their respective markets. In the basic model, the TO and the ISP engage in pricecompetition in a game �a la Stackelberg, where the TO is the leader and the ISP

the follower. The total price paid by consumers is a two-part tariff: a fixed fee

for the access and a quantity-dependent sum for the connection. The independent

solution, where both monopolists set their prices without caring about comple-

mentarity of services, is compared with the contractual one, where the TO offers

a fixed amount if the ISP sets the access price to zero. Whenever the Internet mar-

ket is sufficiently developed – in a sense that will be clearer later on – the contrac-

tual solution is welfare-improving.The paper is organized as follows: Section 2 presents the model. In Section 3, we

solve for the independent and contractual solutions, while Section 4 is dedicated to

welfare analysis. Section 5 analyses some extensions to the basic model, while Section

6 provides some concluding remarks.

2. The model

Let us start by describing the consumers� behaviour. They are heterogeneous with

respect to Internet preferences. Their heterogeneity is characterized by a parameter hiuniformly distributed between 0 and H, i.e. hi � U[0,H]. Since hi represents the ith

consumer�s willingness to pay for the first unit of information exchanged by Internet,

we assume that, even though we do not explicitly model the technological progress,

hi raises whenever the available Internet services raise.

The ith consumer�s problem is to maximize a concave two-time differentiable util-

ity function under two constraints:

2 F3 V

maxxiP0

Ui ¼ maxxiP0

hixi �x2i2þ yi

� �ð1Þ

s:t: yi þ t þ pxi 6 mi; ð1aÞ

CSi P t; ð1bÞ

good, t is the fixed part of the Internet price due to the ISP, p is the quantity-propor-tional part due to the TO, mi is the consumer�s budget and CSi is his surplus. At this

point, we need to introduce a further hypothesis: the operators know the distribution

of hi, not the particular hi for each consumer i. Without this assumption, the model

would fall back into the first-order price discrimination in which:

‘‘. . . the profit maximizing policy is to set price equal to marginal cost and setan entrance fee that extracts all of the consumers� surplus’’. 3

Substituting back (1a) in (1) and maximizing for xi we get:

xi ¼ hi � p

Now consider (1b). We can rewrite it in the following way:

CSi ¼Z p¼hi

p�xiðhi; pÞ dp ¼

Z p¼hi

p�ðhi � pÞ dp P t:

This constraint implies that the ith consumer will buy the access-connection services

if and only if his surplus is non-negative. It is the reservation utility constraint. With

this further condition, the ith consumer�s demand becomes:

xi ¼hi � p if CSi P t and hi > p;

0 otherwise:

The TO and the ISP exhibit a constant return to scale technology, with unit cost nor-

malized to zero, and maximize their profit functions:

max PTO ¼ max pX ð2Þ

s:t: 0 6 p 6 H ð2aÞ

max PISP ¼ max tq ð3Þ

s:t: 0 6 t 6 CSI ; ð3aÞ

RHhixiðhi; pÞ dhi; hi is the res-

ervation price of the consumer who is indifferent between buying the service or not,that is the consumer for whom the rationality constraint holds with equality; H is the

or example, the number of byte.

arian (1989, p. 605).

reservation price of the consumer with the highest willingness to pay; q is the fraction

of consumers buying both services, that is, given the distribution of hi,q ¼ Prðhi P hiÞ. (2a) and (3a) are the constraints on the operators� prices. I in CSI

is the consumer with hi = H. The left-hand side of the price inequalities are the

non-negativity price constraints, and the right-hand side of the inequalities guaranteethat at least one consumer is willing to buy the services.

The timing of the game is the following: in the first step the TO chooses whether

to offer the contract to the ISP or not. In the latter case, we get the standard solution

of price competition �a la Stackelberg. In the former case the sum offered by the TO

must satisfy the ISP�s rationality constraint. The contract consists of a fixed sum to

the ISP, provided the ISP itself sets is access price to zero. If the ISP accepts the con-

tract, the TO maximizes his profit function by taking into account the disbursement

for the ISP.

3. The solution of the model

Before solving the problem of the TO and the ISP with respect to prices, to obtain

the Nash equilibria of the game described above, we must determine the consumers�total demand schedules for both operators. To do that, we use the definition of indif-

ferent consumer. Given (1b), there exists 4 a consumer for whom the constraint isbinding, that is a consumer whose net surplus is equal to the fixed part of the Internet

tariff. Analytically:

if hi � U ½0;H� ) 9 hi : CSi ¼ t:

The reservation utility condition can be rewritten as

CSi ¼Z p¼hi

p�xiðhi; pÞ dp ¼

Z p¼hi

p�ðhi � pÞ dp:

Solving the integral, we get:

CSi ¼ðhi � pÞ2

and finally, we get the hi for the indifferent consumer:

hi ¼ p �ffiffiffiffi2t

p: ð4Þ

Since both p and t must directly influence the reservation price of the indifferent con-

sumer, only the solution with the plus has economic sense.

Given hi, we can retrieve X and q. X is the integral, with respect to hi, of consum-ers� demand for all i such that hi P hi, that is:

his holds true if CSI P t and p6H. Otherwise nobody will buy.

X ¼Z H

xiðhi; pÞ dhi ¼Z H

ðhi � pÞ dhi ¼h2i2

� �Hhi

� ½phi�Hhi ¼H2 � h

2� pðH� hÞ:

The total demand for accesses, that is the share of consumers who want to buy the

service, is the complement to one of the cumulated distribution function of the r.v. hi,that is

q ¼ Prðhi P hiÞ ¼ 1� F ðhiÞ ¼ 1�Z hi

Hdhi ¼

H� hiH

Substituting back hi from (4) in the above expressions for X and q, we get the total

demands for TO and ISP:

X ¼ 1

2H2 � 1

2ðp þ

ffiffiffiffi2t

pÞ2 � pðH� p �

ffiffiffiffiffiffiffiffi2T Þ

p; ð5Þ

q ¼ 1� p þffiffiffiffi2t

H: ð6Þ

Given the solutions (5) and (6), we can now find the Nash equilibrium with respect toprices.

The interaction �a la Stackelberg, with the TO leader and the ISP follower, requires

to solve for the problem of the follower first. Let us start looking for the independent

solution, that is, the solution in which none of the two operators takes care of the

complementarity of services.

The ISP�s problem is:

maxtP0

PISP ¼ maxtP0

tq ¼ maxtP0

t 1� p þffiffiffiffi2t

From the first-order conditions, we get the ISP�s reaction function:

tðpÞ ¼ 2

9ðH� pÞ2:

The TO�s maximum problem is:

maxpP0

PTO ¼ maxpP0

pX ¼ p1

2H2 � 1

2ðp þ

ffiffiffiffi2t

ffiffiffiffiffiffiffiffi2T Þ

p� �:

Substituting back in the TO�s problem the ISP�s reaction function we get, from the

first-order condition, two solutions in prices:

p ¼ H and p� ¼ 1

but, from the second-order conditions, only p* is a maximum point of PTO. The

solution for t* is then:

t� ¼ 8

Once p* and t* are solved for, we have:

X � ¼ 10

q� ¼ 2

P�TO ¼ 10

243H3;

P�ISP ¼ 16

729H2:

Having obtained the independent solution, we assess the possibility that the TO

offers a fixed-sum contract to the ISP, if the latter sets the access price to zero.

The behaviour of the TO is sensible because access and connection are complemen-

tary services. The access price induces a negative externality on connection demand.

Removing this externality by a contract, the TO might improve his welfare. To do

that, he needs to take into account that the ISP will accept the contract if and only

if his welfare is at least as good as if he sets his price independently.

In the real world the TO does not offer a fixed-sum contract because of the moralhazard incentive for the ISP to produce low quality services. The ‘‘real world’’ con-

tract is a variable contract, in which the payment is proportional to connection

length or to data traffic. Excluding the moral hazard problem it is easy to show that

fixed or variable contracts are equivalent, if the payment per unit of time in the pro-

portional case, a, is such that:

a ¼ PISP

Then, a(pX) is the TO�s revenues fraction that the ISP would have received if the con-

tract had been in a variable form. Given the ISP�s profit and the TO�s demand above,

we have:

a� ¼ P�ISP

X � ¼ 4

For any ~X > X �, we would have ~a < a�.Once the contract is offered, it can be either accepted or rejected by the ISP, who,

in case of acceptance, sets t = 0. With this access price, the connection is bought by

all the consumers with hi P p*. Eq. (4) becomes:

~h ¼ p ð4aÞ

~X ¼Z H

xiðhi; pÞ dhi ¼H2 � ~h

2� pðH� ~hÞ; ð5aÞ

~q ¼ Prðhi P ~hiÞ ¼ 1� Fð~hiÞ ¼ 1�Z ~hi

Hdhi ¼

H� ~hiH

: ð6aÞ

Now we must only solve for the problem of TO, given that he guarantees to the

ISP the same profit as before. The new TO�s profit function becomes:

~PTO ¼ p~X �P�ISP:

This new profit function is simply a vertical translation of the old one, hence it has

the same maximum argument, that is p ¼ 13H. The TO�s profit becomes:

~PTO ¼ 2

27H3 � 16

and the demands:

~X ¼ 2

~q ¼ 2

Once the two solutions have been obtained, we must compare them to understand

which one is preferred, both from the social welfare and from the operators� point ofview. The next step is, then, to analyse the total profit and the total welfare in both

cases.

Given that the ISP�s profit is the same, we only need to compare the TO�s profitsin the two different cases.

Proposition 1. The contract is preferred to the independent solution if H > 23.

Proof. To prove the proposition, we need to find the value of H such that:

~PTO ¼ 2

27H3 � 16

729H2 > P�

TO ¼ 10

hence H ¼ 23. h

What does this condition means? Given that H is the willingness to pay of the

consumer with the highest willingness to pay, we assume that this parameter is linkedto the market development. The greater the number and/or the higher the quality of

the Internet services, the higher will be the willingness to pay for those services.

Then, we conclude that the contractual solution is preferable if the market, and hence

the technology, is sufficiently developed.

In spite of the differences between this model and the Haan�s (2001) one, the con-clusions explaining free access phenomenon, at least in qualitative sense, are the same.

Indeed, one of the main differences between the two papers is that we do not need to

introduce fixed costs in contracting to explain why free Internet access does notemerge at the same time the market emerges. In our model it only depends on the

model�s parameters – that is, on the market development.

4. Welfare analysis

Given that the total price paid by consumers in the contractual solution is lower

than that of the independent one, it is easy to imagine that the overall consumers�welfare is greater in the first case. Furthermore, we point out that:

Proposition 2. The social welfare (as the sum of the consumers� surplus, the TO�s andISP�s profits) in the contractual solution is greater than the one in the independent

solution if H > 619. This level of market development is lower than the one needed to

produce a private incentive for the TO to offer a contract to the ISP. 5

Proof. To prove the proposition, the overall consumers� surplus is to be computed.

Starting with the independent solution, the total surplus is the integral, with respect

to hi, of the difference between the net surplus and t:

CS� ¼Z H

hi � pð Þ2

2� t

" #dhi ¼

2187H3

hence the social welfare is:

W � ¼ CS� þP�TO þP�

ISP ¼ 28

2187H3 þ 10

243H3 þ 16

729H2: ð7Þ

When the contract is offered, the new overall consumers� surplus is:

~CS ¼Z H

hi � pð Þ2

" #dhi ¼

and the social welfare is:

~W ¼ ~CS þ ~PTO þP�ISP ¼ 4

81H3 þ 2

27H3 � 16

� �þ 16

729H2 ð8Þ

Comparing ~W and W � we have ~W > W � if H > 619. h

Even though the contract cannot remove the inefficiency, in terms of welfare loss,

due to the monopolistic behaviour of the TO, it however eliminates the loss due to

the competition between the TO and the ISP. Without the contract the Internet serv-

ices would be only bought by consumers with net surplus larger than or equal to the

fixed fee for the ISP. In the contractual solution, once the minimum development le-

vel is reached, each consumer with net surplus larger than or equal to zero buys the

Internet services.

5. Extensions

This section extends the model to analyse the consequences of different allocations

of contractual power between the ISP and the TO. In the basic model, we assumed

his is true in the utilitarian welfare function, in which all agents have the same weight.

that the TO had a greater contractual power. Now we want to see what happens

when the ISP is the leader, or when the power is equally distributed between the

TO and the ISP.

In both cases, the consumers� problem is the same as in the basic model, hence the

total access and connection demands are the same. If the leader is the ISP, we mustsolve the problem of the TO�s first, to obtain the Nash equilibrium in prices.

Solving the TO�s maximization problem

pair of

maxpP0

PTO ¼ maxpP0

we get the reaction function pðtÞ ¼ 23� 1

ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiH2 þ 6t

p. From the second-order condition,

only the negative solution is a maximum point. Substituting back this price, with q

and hi, in the ISP�s profit function, we have the unique real solution 6 for access price:

t� ’ 0:2117H2:

This is, from the second-order condition, a maximum point for all H but H = 0. Gi-

ven t*, we have:

p� ’ 0:1644H;

q� ’ 0:1848;

X � ’ 0:1374H2;

P�TO ’ 0:0226H3;

P�ISP ’ 0:0391H2:

If the TO offers a contract to the ISP, we get back the solution described in the

basic model, with the only difference that now, to satisfy the ISP�s individual ration-ality constraint, the TO�s and ISP�s profits have to be, respectively:

~PTO ¼ p~X �P�ISP ’ 2

27H3 � 0:0391H2;

P�ISP ’ 0:0391H2

while ~p, ~t, ~X and ~q are the same as in the basic model.

Confronting the profit in the independent and contractual solutions we conclude

Proposition 3. The contractual solution is preferred to the independent one if

H > 0.7601.

Proof. We find this value solving the inequality ~PTO þ ~PISP > P�TO þP�

ISP. h

In the next step, we compare total welfare arising from the contractual solution

with that resulting from the independent solution. The total consumers� surplusesin both cases is, respectively:

e emphasize this period because solving the ISP�s problem we get a real solution and a conjugate

complex solutions.

CS� ¼Z H

hi � pð Þ2

2� t

" #dhi ’ 0:0122H3;

~CS ¼Z H

hi � pð Þ2

" #dhi ¼

81H3 ’ 0:0494H3

hence:

Proposition 4. The contractual solution is preferred to the independent one, in terms of

social welfare, if H > 0.4412.

Proof. H = 0.4412 is threshold beyond which ~W ¼ ~CS þ ~PTO þP�ISP > CS� þP�

TOþP�

ISP ¼ W �. h

If the contractual power is evenly distributed between the ISP and the TO, we use

a framework a la Bertrand. In the case of the independent solution, the TO�s and

ISP�s reaction functions are, respectively:

pðtÞ ¼ 1

2H2 � 1

2ðp �

ffiffiffiffi2t

pÞ þ pðp �HÞ;

tðpÞ ¼ 1� p þffiffiffiffi2t

H� 1

ffiffiffiffi2t

From the simultaneous solution, we get two pairs of prices:

p ¼ H; t ¼ 0;

p� ¼ 5

23H; t� ¼ 72

but from the second-order conditions only p* and t* are maximum points. Corre-

sponding demands and profits are:

X � ¼ 90

529H2;

q� ¼ 6

P�TO ¼ 450

12167H3;

P�ISP ¼ 432

12167H2:

If the ISP accepts the contract, the TO�s profit becomes:

~PTO ¼ 2

27H3 � 432

12167H2

while prices and demands are the same as in the contractual basic case.

Comparing the profits we get:

Proposition 5. The contractual solution is preferred to the independent one if

H > 0.9573.

Total consumers� surplus is, respectively:

CS� ¼ 252

12167H3

in the independent solution, and

~CS ¼ 4

in the contractual one.

Given these results, and calculating the total welfare, we conclude that:

Proposition 6. The contractual solution is preferred to the independent one, in terms of

social welfare ð ~W > W �Þ, if H > 0.5399.

After all the possible timing schemes have been analysed, we can conclude that,regardless of the leadership, a level of market development beyond which the con-

tractual solution is preferred to the independent one always exists.

Finally, we want to explore the case of integration between the two operators,

that is when the TO and the ISP merge into a single monopolist firm. The reason

is that it represents the classical way to remove negative externalities by solving

the double marginalization problem. Furthermore, this is the practical solution

adopted by some TOs.

When the access and connection are offered by a single integrated monopolist, theunique profit function becomes:

max PM ¼ max pX þ tq

s:t:0 6 p 6 H;

0 6 p 6ðH�pÞ2

Maximizing the profit function we have two pairs of solutions:

p� ¼ Hð5H� 4Þ2H2 þ 7H� 4

; t� ¼ 2H4ðH� 2Þ2

ð2H2 þ 7H� 4Þ4;

p ¼ � H

2H2 � 1; t ¼ 2

ð2H2 � 1Þ2:

From the second-order conditions only the first pair of prices could be a maximum

point. The second-order conditions imply:

�Ppp

��p�; t�

< 0 for H >1

�Pttjp�; t� < 0 for 0 < H <1

2[ 2 < H < 1;

� det jH j ¼ PppPtt � Ppt

� 2h i��p�;t�

> 0 for 2 < H < 3:9043:

From the conditions above we see that the profit function has a maximum only in

the parametric subset 2 < H < 3.9043. This is a subset of a set generated by the profit

function constraints. In fact, substituting back p* and t* in the constraints, the do-main is restricted in the parametric subspace H > 4/5.

In evaluating the feasibility of free Internet access, we must limit our analysis to

the subset 2 < H < 3.9043, even though this limitation seems to be very restrictive.

Given p* and t* profit and demands become: 7

P�M ¼ 18

H5ð4H2 � 7Hþ 4Þð2H2 þ 7H� 4Þ3

X � ¼ 6H4

ðHþ 4Þð2H2 þ 7H� 4Þ;

q� ¼ 6H

ð2H2 þ 7H� 4Þ:

If the monopolist sets t* = 0, we get back the same solutions previously obtained in

the cases of two distinct operators. The only difference is that now the monopolist�sprofit is equal to the sum of those of the TO and the ISP. That is:

~PM ¼ 2

~XM ¼ 2

~qM ¼ 2

Confronting the two profits we see that ~PM > P�M for 0 < H < 1/2 and for H > 2.

With respect to the total welfare, since the total consumers� surpluses are

CS� ¼ 36 H6ðH�1Þð2H2þ7H�4Þ3 and

~CS ¼ 43

H6ðH3þ3H2þ3Hþ1Þð2H2þ7H�4Þ3 , we have that the total welfare, when

the monopolist sets t = 0, is larger then the one obtained with t 6¼ 0, that is~W M > W �

M , for 0 < H < 1/2, 0.8973354394 < H < 2 andH > 2. Since we have reduced

the parametric subset for H in the interval (2, 3.9043), in order to solve for the max-

imum problem, we conclude that:

Proposition 7. If 2 < H < 3.9043 it is always convenient to set t = 0, both for the

monopolist and from the social welfare point of view.

ote that now the demand for access is not a real number, like in the previous cases, but is a function

6. Conclusions

This paper investigates the economic rationality of free Internet access. Firstly,

we find that, when the Internet market is sufficiently developed, the contractual

solution, by which the TO provides a lump sum transfer to the ISP if the latterfixes his price – the access price – to zero, is welfare-improving. Secondly, this re-

sult does not depend on the allocation of contractual power. The latter only causes

a change in the threshold level above which there is an incentive in contracting,

together with the redistribution of profits between the TO and the ISP. Anyway,

we might order the different interaction schemes in the following way: the lower

the threshold the higher the rank. According to this rule, the TO leadership pro-

vides the highest social welfare. The ISP leadership represents the intermediate

case. Finally, the Bertrand scheme is associated with the lowest level of socialwelfare.

The case of integrated monopolist needs a more careful interpretation. In fact, we

must restrict our analysis to the subset (2, 3.9043) for H. If this condition is verified,

then the free access is always convenient, both for the integrated monopolist and

from the social welfare point of view.

Even though we have analysed the case of integrated monopolist, the model does

not take into account, at least explicitly, one of the most important thing about the

electronic communication network and service markets, namely that they are regu-lated markets. With reference to the European legislation (recently the Framework

Directive 2002/21/EC, and before that the Directives 96/19/EC) the inspiring princi-

ples of the European Regulator are: users must derive maximum benefit in term of

choice, quality and prices; prices must be costs-oriented; tariffs must be transparent;

no discrimination should occur between undertakings providing equal services (and

so on). Furthermore, according to the Framework Directive, Member States shall

require undertakings which have special or exclusive rights, to ‘‘(a) keep separate ac-

counts for the activities associated with the provision of electronic communicationsnetworks or services, to the extent that would be required if these activities were car-

ried out by legally independent companies, so as to identify all elements of cost and

revenue, with the basis of their calculation and the detailed attribution methods

used, related to their activities associated with the provision of electronic communi-

cations networks or services including an itemized breakdown of fixed asset and

structural costs, or (b) have structural separation for the activities associated with

the provision of electronic communications networks or services’’. This regulatory

framework justifies the assumption of absence of first-degree price discriminationwith respect to the consumers, and the minor weight attached to the analysis of

the integrated monopolist.

Acknowledgements

I am grateful to Alberto Iozzi for very useful comments. Furthermore, I thank

two anonymous referees for their suggestions.

References

Haan, M., 2001. The economics of free Internet access. Journal of Institutional and Theoretical

Economics 157, 359–379.

MacKie-Mason, J.K., Varian, H., 1995. Pricing congestible network resource. IEEE Journal of selected

Areas in Communications 7, 1141–1149.

Tirole, J., 1998. The Theory of Industrial Organization. MIT Press, Cambridge, MA.

Varian, H., 1989. Price discrimination. In: Schmalensee, R.L., Willig, R.D. (Eds.), Handbook of Industrial

Organization, vol. 1. North-Holland, Amsterdam, pp. 597–654.

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