Mobile Termination, Network Externalities, and Consumer Expectations

JEL Classification Codes: D4; K23; L51; L96.-- Trabajo presentado a: "11th SAET Conference" celebrada en Portugal en 2011; "An international workshop by TILEC (Tilburg Law and Economics of Media and Telecommunication)" celebrado en Paises Bajos en 2011; "NET Institute Conference on Network Economics" celebrada en USA en 2010; "The 8th Annual International Industrial Organization Conference" celebrada en Canada en 2010.We re-examine the literature on mobile termination in the presence of network externalities. Externalities arise when firms discriminate between on- and off-net calls or when subscription demand is elastic. This literature predicts that profit decreases and consumer surplus increases in termination charge in a neighborhood of termination cost. This creates a puzzle since in reality we see regulators worldwide pushing termination rates down while being opposed by network operators. We show that this puzzle is resolved when consumers' expectations are assumed passive but required to be fulfilled in equilibrium (as defined by Katz and Shapiro, AER 1985), instead of being rationally responsive to non-equilibrium prices, as assumed until now.Sjaak Hurkens gratefully acknowledges financial support through grant ECO2009-12695 from the Spanish Ministry of Science and Innovation, through grant CONSOLIDER-INGENIO 2010 (CSD2006-00016), and thanks the support of the Barcelona GSE research network, and of the Generalitat de Catalunya. Ángel Lóez gratefully acknowledges the financial support from the Spanish Ministry of Science and Technology under ECO2008-05155 and from Juan de la Cierva Program.Peer reviewe