pacity can lead to delays or blocked calls in a circuit-switched network or dropped packets in a packet-switched network. This chapter considers the problem of setting prices for capacity when congestion affects service quality. It is tempting to refer to quality-of-service effects as a congestion externality, but there are misleading implications from this loaded term. It is certainly true that there are formal similarities to classic externalities such as pollution. The reasoning proceeds as follows. One person's consumption of network services, which lead to capacity usage, negatively affects another person's benefit from consumption of network services. A consumer takes into account the benefits received from consumption of network services, but presumably is indifferent to the costs that such consumption imposes on others. Without any rationing of capacity, congestion will increase to the point where each user's marginal benefits from consumption are exhausted. The allocation of network services would necessarily be inefficient. 10 Discriminatory auctions are efficient in the unit-demand case. When buyers demand multiple units, the auctions may fail to be efficient, as Vickrey (1961) recognized. Pricing Network Services The problem with the congestion externalities approach is that network services usually are not free. Network firms charge for retail access to network services. Thus, access is rationed by price. Because the consumers of a network engage in transactions with the network, congestion effects are not external to the market. Network congestion effects are internal to transactions between consumers and the network. Consumers may not be aware of the congestion effects they create, but the network firm is certainly aware of these effects. The network firm chooses prices and capacity with an understanding of the effects of usage on quality of service. Thus, the network's prices internalize the effects of usage on congestion. Congestion effects may take the form of externalities if government regulat