Welfare Analysis of Network Neutrality Regulation

Abstract

Consumers of Internet content typically pay an Internet Service Provider (ISP) to connect to the Internet. A content provider (CP) may charge consumers for its content or may earn via advertising revenue. In such settings, a matter of continuing debate, under the umbrella of net neutrality regulations, is whether an ISP serving a consumer may in addition charge the CPs not directly connected to the ISP for delivering their content to consumers connected to the ISP. We attempt an answer by looking at the problem through the lens of a regulator whose mandate is to maximize the cumulative welfare of ISPs, CPs, and consumers. Specifically, we consider a two-sided market model, in which a local monopoly ISP prices Internet access to consumers and possibly to CPs as well. The CPs then decide whether to enter a competitive but differentiated market and the consumers decide whether to connect to the ISP. Unlike prior works, we model competition between the CPs together with consumer valuation of content and quality-of-service provided by the ISP. We do so by using a novel fusion of classical spatial differentiation models, namely the Hotelling and the Salop models, in addition to simple queue theoretic delay modeling. Via extensive simulations, we show that the equilibrium in the non-neutral setting that allows an ISP to charge a CP welfare-dominates the neutral equilibrium.