The Economics of e-Commerce and the Internet
Edward J. Deak, Ph.D.
Ch. 3 – Answers for Discussion and Review Questions
1. Identify and explain the significance of the technical and functional differences
and interdependencies that exist between the Internet and the World Wide Web.
The Internet is an electronic network of computer networks. It links individual
computers together through their different networks. It is a message-based
communications system allowing the transfer of text and data, voice and images.
The transfer of e-mail is one common use of the Internet. The World Wide Web
is another common application that utilizes Internet technology. It is an
information-based system whose purpose is to organize and manage facts,
allowing quick and easy access to that information from one site to another. It is
driven by a browser technology based upon simple language commands and a
system of hyperlinks. The Internet existed for 20 years prior to the introduction
of the World Wide Web. However, the significance of the latter is that it gave
average users easy access to the Internet, while greatly multiplying the number of
interesting things that might be accomplished via the electronic interconnection
2. Initially, the United State government funded the research, development and
operation of the Internet. Would funding from the private sector have been as
efficient or even better as an incubator source for the Internet? Why?
Entrepreneurial investment by the private sector is driven by the profit motive,
while the U.S. government was motivated to fund the Internet by the desire to find
a more secure communications system that would enhance the level of national
defense. Given the high risks associated with the possible failure of new
technology and the absence of an obvious early commercial application, it is
unlikely that the private sector would have developed the Internet, or at least as
rapidly as the governmental sector did.
3. The initial development of the World Wide Web was undertaken primarily by
private research and commercial enterprises. Was this source the most efficient
support for the Web? Why?
The Web first appeared as the result of individual effort designed to solve an
information management problem. Initially the Web was an open and trusting
system where commercial entrepreneurs saw a profit potential. The Web has
grown globally and rapidly as an information and commercial entity based upon
the highly diverse efforts, motives and skills of millions of participants. Given
that economic efficiency means acquiring output at the lowest resource cost or the
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achievement of maximum output at a given level of resource expenditure, private
development of the Web was most likely the most efficient route. Note that
economic efficiency and markets offer no judgment about the moral, ethical or
distributional consequences of the final result. The existence of Spam, cybersex,
e-gambling and other unregulated uses of the Web may led some observers to
legitimately question the value of private development.
4. How did Moore’s Law and the economics of chip making combine to speed the
spread of personal computers, as well as the urge to connect to the Internet and
Moore’s Law postulates that technology will allow the number of transistors on a
silicon computer chip to double every 18 months. Abiding by this law effectively
doubles the computing power of a desktop or laptop computer every 18 months.
The economics of chip making combined economies of scale with efficiencies
associated with the learning curve to substantially reduced the manufacturing
costs of producing increasingly more powerful computer chips. Together these
forces simultaneously reduced the cost and expanded the power of personal
computers, allowing more users to have cheaper access to the Internet and to do
an ever-increasing number of interesting things on the Web.
5. How did the Web reinforce the spread of personal computers?
At first, personal computers were mostly used as business machines serving as
more efficient, stand along substitutes for typewrites and calculators. The ability
to “surf the Web” gave non-business persons an attractive application and a
reason for owning and using a personal computer.
6. How does the technology of a computer network expand upon and improve the
economics of a television network? What characteristics of a network help to
make the Web such a valuable vehicle for conducting e-commerce transactions?
The economics of a television network such as NBC, ABC or CBS involves
broadcasting a program such as CSI or Friends on a fixed date and time by linking
together a collection of local affiliates. Fans of a particular program must adjust
their personal schedule to fit the broadcasting schedule of the TV network. A
computer network is more flexible and allows contact with an entertainment or
commercial site at the convenience of the viewer. It is comparable to the video-
on-demand service that is becoming available on many cable TV systems. The
movie starts when you want it to start. A computer network is valuable for e-
commerce because it is available 24/7 whenever the customer would like to
purchase an item or gain some information.
7. What is the last mile problem? How does this problem affect the spread of e-
commerce and the profitability of Internet infrastructure investments?
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The last mile problem is that while Internet information is carried over fiber-optic
cables at the speed of light, the final connection to the home or business is often
made using older and much slower copper wire telephone lines. This limits the
speed at which signals can be exchanged and lengthens the amount of time
needed to fully transmit a complete signal such as a movie file or animated video
game. This last mile based speed and time barrier limits the range of activity that
can be transmitted over the Internet and discourages larger investments in Internet
infrastructure until the problem can be solve. Speedier broadband cable and
telephone DSL links help to overcome parts but not all of the last mile problem.
8. Refer to the capital and labor example that illustrates the cost-minimization rule.
If the sample numbers hold for the extra worker, why would any firm wish to ever
employ an extra unit of capital? [Hint: Return to Chapter 2 and the discussion of
diminishing marginal returns to find the answer to this question.]
In the short-run, both capital and labor are subject to the Law of Diminishing
Marginal Returns. For the next extra worker the cost per unit of added output is
greater than that of an extra unit of capital. However, if an added worker after
that is hired the marginal product of the second added worker will decline given
that the person is working with a fixed amount of capital. Even if the per unit
labor cost shown in the denominator doesn’t increase, eventually diminishing
returns shown in the numerator will fall low enough to encourage the firm to add
an extra unit of capital rather than one more worker.
9. State the cost-minimizing rule. Explain how this rule helps to resolve the fiber
optic research tension.
The cost-minimizing rule states that the profit maximizing firm should hire
resources such that:
Marginal Product of Resource A = Marginal Product of Resource B
Marginal Cost of Resource A Marginal Cost of Resource B
The fiber optic research tension pits the cost of increasing the volume and speed
of data flow over each wavelength of light against the cost of a research agenda
focusing on increasing the number of wavelengths with each carrying more data
but at a slower speed. Using the cost-minimizing rule to adjust the incremental
output from each strategy by the added cost of achieving the output should help to
yield the correct answer to the problem.
10. How does competition in product diversity usually affect the efficiency of the
marketplace? Does this conclusion necessarily hold true for the technical
diversity of cell phone connection standards in the United States? Why?
Product diversity in the marketplace usually provides added benefits to the
consumer. Product diversity allows buyers to better tailor their purchases to
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individual tastes and preferences. However, diversity among technical cell phone
standards may be valuable only up to the point where one standard is proved to be
superior to the others. At this point, the winner is adopted as a universal standard
allowing smoother, cheaper and more efficient communications among all parties.
The adoption or competitive triumph of a universal standard has not happened a
yet in the U.S. Therefore, national usage, research and product development tend
to lag behind other nations where a universal standard has been determined.
Having universal standard breeds system wide economies of scale and
interoperability that are lagging in the U.S.
11. How does the diversity of cell phone connection standards in the United States
affect the global competitive position of United States wireless service providers?
The U.S. is a big cell phone market. However, with multiple connection
standards, infrastructure investments are duplicated and phone manufacturers do
not obtain the same economies of scale that are found in Europe or Asian markets.
Research and the adoption of new products have been somewhat hindered to date
by the diversity of U.S. standards. U.S. firms are not the undisputed leaders in
world cell phone technology and phone manufacturing that their skills might
otherwise allow them to be. With standardized cell phone technology, Europe or
Japan may have a head start on the U.S. allowing them to establish the next
generation of standards, products and jobs associated with more advanced cell
12. Distinguish between 1G, 2G and 3G in terms of wireless telephone services.
1G, or first generation wireless service, was the original analog cell connection
providing just the voice connection. 2G service, is generally the cell service that
is available today, which combines voice with limited messaging via the alpha
numeric characters on the phone screen. Internet interconnection is possible with
this system but transmission speeds are slow, costly and complicated by the
existence of multiple connection standards. 3G service involves high speed
Internet connections via cell phone technology. This service requires the
purchase and introduction of additional bandwidth in the radio spectrum and has
proven to be very expensive for both U.S. and European phone firms to acquire as
well as to introduce.
13. What are the obstacles to the expansion of 3G cell phone service in the United
First, there are competing multiple connection standards that raise the cost of
introducing 3G in the U.S. Second, the service requires the purchase of expensive
additional frequencies in the radio spectrum. Third, there is no guarantee that
consumers will want to access the Internet via cell phones. Lastly, there is a
competing technology called Wi-Fi that allows cheaper short-range Internet
connections for laptops and other hand held devices.
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14. Assume for the moment that you are the chief executive of a major wireless phone
company such as AT&T Wireless. What conditions or characteristics might make
the delivery of 3G wireless Internet service via cell phones more popular? What
might you do to enhance the number of 3G subscribers?
Service price is always an important characteristic. The key is to get large
numbers of people to use the service and thereby spread the fixed infrastructure
charges over many customers, thereby reducing the cost of service per person.
Having interesting applications such as the ability to transmit pictures, or send
instant messages, might stimulate demand. Lastly, making the service as easy to
use as possible would allow more persons of average technical skill to operate and
benefit from the service.
15. What might be the economic worth of the Web to Berners-Lee if he had decided to
patent the technology and code? Would the growth of the Web have been so
rapid if it was a patented product for sale? Why would someone give away such
a valuable idea? Why do thousand of people participate, for free, in the various
@home computer search projects?
DOS and Windows have made Bill Gates, the principle owner of Microsoft, the
richest person in the world with an estimated net worth of some $46 billion. The
proprietary economic value of the Web could rival or exceed the value of
Windows. However, as a proprietary property, the spread of the Web might not
have been as rapid or might have spawned competing systems. Tim Berners-Lee
might be called an altruist, or a person who does things for the good of others,
rather than for self-interest. It was his view that the Web should be both open and
free in the monetary as well as the intellectual sense. Berners-Lee has steadfastly
fought for openness and dedicated his later contributions to the Web in ways that
are consistent with this view. People who participate for free in @home computer
search projects are also altruists, who get their reward not from money, but from a
sense of helping others and advancing the frontiers of scientific knowledge.
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