Abstract

We discuss the effects of strategic commitments and of network size in the
process of setting of interconnection fees across competing networks. We
also discuss the importance of the principles of reciprocity and imputation
of interconnection charges on market equilibria. Reciprocity means that both
networks charge the same for interconnection. Imputation means that a
network charges its customers as much as it charges customers of the other
network for the same service. We first discuss a game of strategic symmetry
where the two networks choose all prices simultaneously. Second, we allow a
dominant network to set the interconnection fee before the opponent network
can set its prices. This results in a price-squeeze on the opponent network.
Third, we show that the imposition of reciprocity eliminates the strategic
power of the first mover. Under reciprocity, one network sets the common
interconnection fee at cost, and the equilibrium prices for final services
are lower than in the two previous games without reciprocity. Moreover,
prices under reciprocity obey the principle of imputation. In the long run,
consumers subscribe to one of the two networks. Typically, there is a
multiplicity of equilibria, including corner equilibria, where all consumers
subscribe to the same network. However, under reciprocity, there are no
corner equilibria.

JEL classification: L1, D4

Keywords: two-way networks, interconnection, reciprocity, imputation.