Classes of service under perfect competition and technological change: a model for the dynamics of the Internet?

TL;DR

This paper models how different service classes and technological change influence the structure of service offerings in markets like the Internet, highlighting regimes with finite or infinite quality classes under perfect competition.

Contribution

It introduces a theoretical framework distinguishing regimes of service class offerings based on economies of scale and demand, applicable to Internet service markets.

Findings

Two regimes: finite classes (BDC) and infinite classes (UDC).

Demand and economies of scale determine the service class structure.

Price structures follow general laws in the discrete class regime.

Abstract

Certain services may be provided in a continuous, one-dimensional, ordered range of different qualities and a customer requiring a service of quality q can only be offered a quality superior or equal to q. Only a discrete set of different qualities will be offered, and a service provider will provide the same service (of fixed quality b) to all customers requesting qualities of service inferior or equal to b. Assuming all services (of quality b) are priced identically, a monopolist will choose the qualities of service and the prices that maximize profit but, under perfect competition, a service provider will choose the (inferior) quality of service that can be priced at the lowest price. Assuming significant economies of scale, two fundamentally different regimes are possible: either a number of different classes of service are offered (DC regime), or a unique class of service offers an unbounded quality of service (UC regime). The DC regime appears in one of two sub-regimes: one, BDC, in which a finite number of classes is offered, the qualities of service offered are bounded and requests for high-quality services are not met, or UDC in which an infinite number of classes of service are offered and every request is met. The types of the demand curve and of the economies of scale, not the pace of technological change, determine the regime and the class boundaries. The price structure in the DC regime obeys very general laws.