This exercise studies the price competition between two major telcos in Australia: Telstra and Optus, and their
Question:
This exercise studies the price competition between two major telcos in Australia: Telstra and Optus, and their relationship with NBN (National Broadband Network). NBN is a publicly-owned, open-access data network wholesaler. Telstra and Optus are retail service providers (RSPs) who contract with NBN to access the data network and sell fixed internet access to end-users. Currently, the most popular home internet plan in Australia is the NBN 50 plan, which provides a theoretical download speed of 50 Mbps. To simplify our analysis, assume NBN 50 is the only plan offered by Telstra and Optus, and they are the only telcos in Australia. Suppose on average NBN charges PN (wholesale price) per customer access to NBN 50 per month to RSPs. Telstra's monthly total cost function is
T CT (QT ) = (PN + 5)QT + 12 million,
where QT is the number of subscribers to Telstra's NBN 50 plan. Similarly, Optus's monthly toal cost function is
T CO(QO) = (PN + 5)QO + 12 million,
where QO is the number of subscribers to Optus's NBN 50 plan. On the other hand, suppose NBN's monthly total cost function is
T CN (QN ) = 17QN + 85 million, where QN = QT + QO is the total number of NBN 50 subscribers.
Let PT denote Telstra's monthly subscription fee and PO Optus's monthly subscription fee. Within
a reasonable price range, QT and QO are determined by the following equations:
QT (PT , PO) = 4 million - 4 million/25 PT + 3 million /25 PO
QO(PT , PO) = 4 million - 4 million /25 PO + 3 million PT
- (2 marks) Write down the profit functions for Telstra and Optus.
- (4 marks) Suppose NBN sets the access fee at PN = $45. Assume that each telco only considers setting the monthly subscription fee at one of the following three values: $60, $65, and $70. Construct a 3x3 payoff matrix for the pricing game between Telstra and Optus and find the Nash equilibrium of the game. Calculate each telco's profits, number of subscribers, and the Herfindahl Index (based on the number of subscribers) in equilibrium.
- (4 marks) Suppose NBN increases PN from $45 to $55. Other things remain the same. Redo (b).
It is reported that the average wholesale price for the NBN 50 plan is $45 in 2020. Civen NBN's monopoly position in the wholesale market and its goal to meet budget requirements imposed by the government to recover the cost of deploying the nbnTM access network infrastructure, NBN is aggressively adJusting its wholesale pricing model over time to meet its targeted average revenue per user. In June 2021, NBN submitted a special access undertaking (SAU) variation
3 to the ACCC for approval. In the SAU, NBN proposes the following three wholesale pricing constructs to be considered by the ACCC (p.10):
B50[50/20] is the pricing for the NBN 50 plan. Under Construct 3, the wholesale price PN of NBN 50 could go up to $55 (so roughly a 20% increase from $45). Tesla said that the new pricing model will push up retail prices. Optus stated that "NBN Co's wholesale pricing model has forced us to revaluate the profitability of some nbn rate plans ... In keeping in line with our commitment to provide a great internet experience, we've had to make some changes and increase the price of some of our nbn Home Internet plans ... From August 2021, the following nbn rate plans will change: The $60 plan will be increased by $10 to $70 per month; the $70 plan will be increased by $5 to $75 per month."
- (4 marks) Based on your answers in (b) and (c), discuss (i) Whether Optus's pricing strategy is consistent with our theoretical prediction? Is it sensible for Optus to increase its prices before NBN implements the new pricing model? (ii) Should Telstra follow suit to adJust its prices? Why or why not?
- (2 marks) Based on your answers in (b) and (c), to maximize profits, should NBN set the wholesale price at PN = $45 or PN = $55? Justify your answer.
The following questions are independent to each other.
- (4 marks) Suppose PN = $45 and the firms move sequentially instead of simultaneously: Telstra sets its monthly subscription fee first. After observing the fee set by Telstra, Optus then sets its monthly subscription fee accordingly. Construct a game tree for this sequential- move game and find the SPNE of the game. Make sure you specify each firm's strategy properly.
- (4 marks) Suppose now NBN and Telstra merge to form a new company called Telstra-NBN (mostly likely Telstra acquires NBN instead of the other way around :)). The demand and cost functions remain unchanged after the merger. Suppose after the merger, Telstra-NBN and Optus play the following two-stage game:
Stage 1. Telstra-NBN sets the wholesale price PN . PN is either $45 or $55.
Stage 2. After observing PN , both Telstra-NBN and Optus simultaneously set their monthly subscription fees PT and PO, respectively. As in (b), the monthly subscription fee can only be set at $60, $65, or $70.
Note that Telstra-NBN operates in both the wholesale and retail markets, and Optus operates only in the retail market. Find the SPNE in this game. Compare your answers with those in
(b), (c) and (e), and discuss the effects of the Telstra-NBN merger on (i) PN , PT and PO, (ii) Each firm's profits, and (iii) Total number of subscribers.
- (6 marks) In (b) and (c) we assume that each telco can only set its monthly subscription fee at $60, $65, or $70, which is an unrealistic assumption. Assume now Telstra and Optus can set its fee at any non-negative value; i.e., PT 2" 0 and PO 2" 0. Redo (b) and (c) with this general setup and determine each telco's optimal pricing strategy in equilibrium. Compare your answers with those in (b) and (c) and discuss the differences.
