Chapter 11 The information economy

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Chapter 11The information economy

• David Begg, Stanley Fischer and Rudiger
  Dornbusch, Economics,
• 6th Edition, McGraw-Hill, 2000
• Power Point presentation by Peter Smith

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e-Economics
The information revolution is here
but economics still provides a reliable
framework to understand what is happening..
This is microeconomics in action
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Use of the internet
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e-products

• An e-product
• can be digitally encoded then transmitted
  rapidly, accurately and cheaply
• e.g. music, films, books, sport
• Fixed costs of producing e-products are huge
• but marginal costs of distribution are tiny
• implying vast economies of scale

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Consuming information
Four key features of e-products

• experience
• overload
• switching costs
• network externalities

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Experience products

• An experience good or service is one that must be
  sampled before the user knows its value
• information is nearly always new
• marketing needs careful attention
• free samples
• previews
• establishing reputation

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Information overload

• arises when the volume of available information
  is large
• but the cost of processing it is high
• screening devices become crucial

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Switching costs

• arise when existing costs are sunk
• so changing supplier incurs additional costs
• smart suppliers devise strategies for locking in
  their customers
• e.g. air miles, supermarket reward cards

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Network externalities
Suppose D1 represents the demand curve for a
product exhibiting network externalities
With price at P1, demand is limited.
If price is reduced to P2, more people find the
network attractive so not only is there a move
along the demand curve, but there is a shift in
demand.
P2
Long-run demand is more elastic (DD).
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Information the supply side

• Given substantial economies of scale, we expect
  monopoly suppliers of information products
• Dominant firm with competitive fringe
• e.g. Microsoft
• Niche market monopolies

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Pricing information products

• Strategies for pricing information products
• two-part tariff
• an annual charge to cover fixed costs, and a
  small price per unit related to marginal costs
• versioning
• the deliberate creation of different qualities to
  facilitate price discrimination
• bundling
• the joint supply of more than one product to
  reduce the need for price discrimination

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Competition vs. collaboration

• A strategic alliance is a blend of co-operation
  and competition, in which a group of suppliers
  provide a range of products that partly
  complement one another
• e.g. Microsoft and Intel
• airline alliances One World, Star

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Understanding the e-economy

• 1 The information revolution is changing our
  lives
• but few of its activities or market tactics are
  unprecedented
• 2 The revolution in technology has not required
  a corresponding revolution in economic theory