The Role of Social Networks on Regulation in the Telecommunication Industry

Abstract

This paper studies the welfare implications of equilibrium behavior in a market characterized by competition between two interconnected telecommunication firms, subject to constraints: the customers belong to a social network. Using numerical approximations we show that social networks matter because equilibrium prices and welfare critically depend on how people are socially related. Next, the model is used to study the effectiveness of alternative regulatory schemes. The standard regulated environment, in which the authority defines interconnection access charges as being equal to marginal costs and final prices are left to the market, is considered as a benchmark. Then, we focus on the performance of two different regulatory interventions. First, access prices are set below marginal costs to foster competition. Second, switching costs are reduced to intensify competition. The results show that the second strategy is more efective to obtain equilibrium prices closer to Ramsey’s level.