A Theory of Interdependent Demand for a Communications Service

The utility that a subscriber derives from a communications service increases as others join the system. This is a classic case of external economies in consumption and has fundamental importance for the economic analysis of the communications industry. This paper analyzes the economic theory of this kind of interdependent demand. We begin by defining "equilibrium user set" as a set of users consistent with all individuals' (users and nonusers) maximizing their utilities. There are typically multiple equilibria at any given price, and which equilibrium is attained depends partly on the static model, partly on the initial disequilibrium conditions, and partly on the disequilibrium adjustment process. Some general properties of equilibrium user sets are derived. Then we turn our attention to some specific models based on simple characterizations of communities of interest. The implications for pricing are discussed, with special reference to the problem of starting up a new communications service (e.g., a video communications service).