Innovation through discrimination!? A Formal Analysis of the Net Neutrality Debate

We model the main arguments of the net neutrality debate in atwo-sided market framework with network congestion sensitive con-tent providers and Internet consumers on each side, respectively. Theplatform is controlled by a monopolistic Internet service provider, whomay choose to sell content providers prioritized access to its customers.We explicitly consider the adverse eects of trac prioritization to theremaining best-eort class and nd that network discrimination hasoverall positive eects on welfare, because congestion is better allocatedto those content providers with congestion inelastic advertisement rev-enues. In the long-run, network discrimination leads to infrastructureinvestments in transmission capacity and encourages innovation onthe content provider side. In the short-run, however, discriminationhas no eect on innovation because the ISP expropriates the contentproviders' increased surplus through the price for priority access. Thisis the downside of network discrimination: Albeit total welfare is in-creased, content providers will{at least in the short-run{be worse othan under network neutrality. Although price regulation can shiftsome of the congestion alleviation gains back to content providers, itis inapt as a policy instrument, because welfare is proportionally de-stroyed in the process.