Review of Industrial Organization 18: 257–262, 2001.
© 2001 Kluwer Academic Publishers. Printed in the Netherlands.
Microsoft’s Pricing of Windows and the Economics
of Derived Demand Monopoly
GREGORY J. WERDEN
U.S. Department of Justice, Washington, DC 20530, U.S.A.
E-mail: gregory.werden @usdoj.gov
Abstract. The economic experts in the Microsoft case debated whether Microsoft’s pricing of
Windows was consistent with Microsoft having a monopoly over personal computer (PC) oper-
ating systems. In this debate, PCs were treated as a single homogeneous commodity. This paper
demonstrates that PC heterogeneity is likely to reduce substantially the monopoly price of Windows.
The reason is that low-end PCs, which surely have the more elastic demand, are of disproportionate
importance in determining the elasticity of derived demand for Windows.
Key words: Computer software, derived demand, microsoft.
JEL Classiﬁcation: D42, L41, L63.
One issue debated by the economic experts in the landmark Microsoft monopol-
ization case was whether Microsoft’s pricing of Windows was consistent with
Microsoft having a monopoly over personal computer (PC) operating systems
(OS). Microsoft’s expert, Richard L. Schmalensee (1999), testiﬁed to calculations
indicating that a PC OS monopolist would set a price vastly higher than Microsoft
did, and opined that Microsoft must have faced considerable competition. This
testimony was bolstered by a Microsoft-commissioned paper authored by NERA
economists Reddy et al. (1999) who worked with Schmalensee. The Justice De-
partment’s expert, Franklin M. Fisher (1999), challenged the validity of many of
Schmalensee’s assumptions and argued that a PC OS monopolist plausibly would
have set a price at roughly the level Microsoft chose. Detailed information on
the license fees actually paid to Microsoft by PC manufactures (OEMs) was not
revealed in the public trial record, but several estimates of the Windows price were
provided. Reddy et al., say that Microsoft charges “about $50” and used the $50
ﬁgure in their calculations. Fisher and Rubinfeld (2000, p. 13) say that ﬁgure is
“about $60”. Schmalensee (2000) says it is “about $65”, and that ﬁgure was used
at various points in the trial. Finally, Plaintiffs’ Joint Proposed Findings of Fact
(1999) state that the price of Windows is “approximately $70”. The precise ﬁgure
is not important for present purposes, and the $50 ﬁgure is used below.
Tim Bresnahan provided helpful comments. The views expressed herein are not purported to
reﬂect those of the U.S. Department of Justice.