DP8670 Experimentation in Two-Sided Markets

Author(s): Martin Peitz, Sven Rady, Piers Trepper
Publication Date: November 2011
Keyword(s): Bayesian Learning, Monopoly Experimentation, Network Effects, Optimal Control, Two-Sided Market
JEL(s): D42, D83, L12
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8670

We study optimal experimentation by a monopolistic platform in a two-sided market framework. The platform provider faces uncertainty about the strength of the externality each side is exerting on the other. It maximizes the expected present value of its profit stream in a continuous-time infinite-horizon framework by setting participation fees or quantities on both sides. We show that a price-setting platform provider sets a fee lower than the myopically optimal level on at least one side of the market, and on both sides if the two externalities are of approximately equal strength. If the externality that one side exerts is sufficiently weaker than the externality it experiences, the optimal fee on this side exceeds the myopically optimal level. We obtain analogous results for expected prices when the platform provider chooses quantities. While the optimal policy does not admit closed-form representations in general, we identify special cases in which the undiscounted limit of the model can be solved in closed form.