Google must face trial … that the internet search juggernaut dominates the online advertising technology market. Google argues … that regulator had not accurately defined the ad tech market.—Reuters, June 14, 2024
Data
Does Google dominate the digital advertising market?
Figure 1 shows the total revenue shares of the firms that compete in the digital advertising market. Each firm uses its own differentiated technology, and the firms range in size from Google with 39 percent and Facebook with 18 percent to an unknown number of very small firms the largest of which is Amazon with 7 percent.
Many independent firms with their own technology compete for market share, so the market looks more like monopolistic competition than monopoly. With two big players in the market, these firms can be viewed as a duopoly.
How do firms in a duopoly set their price and determine the quantity to produce?
Duopolists play a game. Each firm has its own pricing strategy: to set the monopoly price or to set a competitive price. Table 1 sets out the payoff matrix for the game: The strategies of each player and the economic profit that each player makes. Google and Facebook can set a monopoly price and make the monopoly profit.
If Google sets the monopoly price, what action does Facebook take? Facebook will make more economic profit if it sets the competitive price and sells most advertisements. But if Google sets the competitive price, what action does Facebook take? Facebook will make more economic profit it sets the competitive price. So no matter how Google chooses to price its advertisements, Facebook sets the competitive price.
If Facebook sets the monopoly price, what action does Google take? Google will make more economic profit if it sets the competitive price and sells most advertisements. But if Facebook sets the competitive price, what action does Google take? Google will make more economic profit it sets the competitive price. So no matter how Facebook chooses to price its advertisements, Google sets the competitive price.
Google and Facebook don’t make zero economic profit, so the outcome of this duopoly game does not explain a juggernaut that dominates digital advertising. How do Google and Facebook avoid a zero-profit outcome? The answer is that they play a repeated duopoly game.
What is a repeated duopoly game?
If the duopoly plays a game repeatedly, one firm can take the opportunity to penalize the other firm for previous “bad” behavior. If Google sets a competitive price this period, Facebook will set a competitive price next period to penalize Google. But before Google sets a competitive price, won’t it consider the possibility that Facebook will set a competitive price next period?
What is the outcome of a repeated duopoly game?
The outcome is a cooperative equilibrium in which both players set the monopoly price and make the monopoly economic profit. If setting a lower price is punished with a small penalty, the repeated game uses a “tit-for-tat” strategy. That is, if Facebook sets the monopoly price this period while Google sets a lower price, then next period Facebook will punish Google by also setting a lower price. Let’s play the repeated game. Table 2 shows the strategies and the outcomes.
If in period 1, Facebook sets the monopoly price but Google sets the competitive price, Google’s economic profit increases and Facebook incurs an economic loss. In the second period, Facebook penalizes Google for competing so it sets the competitive price. Facebook’s economic profit increases and Google incurs an economic loss. If in the next period, neither firm competes, Table 2 shows that over the three periods, the duopoly makes less economic profit with the tit-for-tat strategy by competing.
Now take a short quiz to ensure you understand what you just read.