Paid prioritization and its impact on net neutrality

The net neutrality debate has been centered at the question: whether price and service differentiation should be allowed for the Internet? We focus on a monopoly market, where regulation is often required, and study the type of service differentiation where an option of paid prioritization is provided for the Content Providers (CPs) by an Internet Service Provider (ISP). We study the ISP´s pricing strategy and the corresponding CPs´ responses. Based on the higher level CPs´ choices of service classes and the lower level traffic equilibrium, we analyze the utility of the ISP and the CPs as well as the social welfare. By comparing the induced social welfare under different settings, we find that ISP´s optimal pricing leads to an efficient differentiation among the CPs such that the social welfare is highly optimized. We also identify the conditions under which the ISP would have a strong incentive to expand its capacity when the market grows. In conclusion, our results support the use of priority-based pricing and service differentiation rather than imposing net neutrality regulations.