Price Competition in Two-Sided Markets with Heterogeneous Consumers and Network Effects∗

In most models of two-sided markets, demand on one market side depends on the numbers of consumers on the other market side, but not on their composition. We document that prices for advertisements in daily newspapers do not only depend on the number of readers, but also on their location, gender and wealth. Motivated by this, we propose a model of a two-sided market with heterogeneous consumers and advertisers whose demand for advertisements depends on the composition of consumers. By setting prices and choosing an editorial line, newspaper publishers cannot only influence how many readers they have, but also their composition. However, as it is often the case in practice, their ability to do so is limited because price discrimination is not possible. We provide a sufficient conditions for demand on each side to be unique given prices on both sides and for the existence and uniqueness of an equilibrium in prices. The conditions are related to the ownand cross-price effects, as well as the strength of the own and cross network effects. Most functional forms used in empirical work, such as logit type demand functions, tend to satisfy these conditions for realistic values of the respective parameters. Then we estimate a flexible model of demand that satisfies the above conditions and study the effects of a shrinking market for offline newspapers on subscription and advertising prices. We find that less price sensitive subscribers are actually more valuable to advertisers, which explains why in the recent years, subscription prices have actually increased. JEL Classification: L13, L40, L82.