Economics of Digital Information

Information, Markets and Society Kathy E. Gill 30 June 2008

Overview
What is an Info Economy?
Economics 101
Types of goods
Network effects
Examples and Discussion

But first ….
This instrument can teach, it can illuminate; yes, and it can even inspire. But it can do so only to the extent that humans are determined to use it to those ends. Otherwise it is merely wires and lights in a box. There is a great and perhaps decisive battle to be fought against ignorance, intolerance and indifference. This weapon of television could be useful.
Edward R. Murrow , 1958, RTNDA Convention

What Is An Info Economy?
“ An economy based on the exchange of knowledge information and services rather than physical goods and services.” Australian Gov’t , Dept. Finance and Administration, 2001.

History of Term, Concept
1963: Tadeo Umesao, Kyoto University, forecast an information industry
1973: Daniel Bell, Harvard, described a knowledge-based post-industrial economy
1981: Frederick Williams, UT Austin, said the communication revolution had arrived and expounded on the “knowledge worker” The Information Society, A Retrospective View. Dordick and Wang. 1993.

Bell
Post-industrial society will be “organized around knowledge for the purpose of social control and the directing of innovation and change”
The transformation is industrial to service
Anticipated tension between high-tech, intellectual work and nonprofessionals

Digital Expectations
Personal anecdote about trying to read journal article, Blackwell Publishing (UK)

Today (almost!)
1997: Bill Gates traced the computer from mainframe to personal to network. “[W]e have the most powerful communications medium of all time… And the information age is changing business in a fundamental way… [as well as] the way we entertain … and … [educate] ourselves.” Information Technology, Corporate Productivity and the New Economy, p 4

No Standard Nomenclature
Info Economy, Post-Industrial Economy, “New” Economy?
One definition: the new economy is an integration of free-market economies, globalization and information technology Information Technology, Corporate Productivity and the New Economy, p 9

What is Information?
In the context of this class, anything that can be converted to bits, ie, digitized, is an information good
Entertainment
News
Business Info
Software

What is Information Technology?
Telecommunications, computers, software
Communication: E-mail, IM, TheWeb
Networks: Extranet, Intranet, Internet, LAN, WAN
Software: Expert systems, Enterprise Resource Planning, Query and Reporting, Data Mining
Networks: T1, T3, Wireless
Protocols: HTTP, FTP, VoIP

Societal Factors
Demand for IT:
Productivity?
Effect of Growth:
Collapse of space and time
Reduction of scarcity

Competing Theories
Technology optimists
A new society without pollution; time for creative work; participatory democracy; perfect markets…
Technology pessimists
No new society but an increase the divide between rich and poor; greater control over individuals; erosion of privacy…
Technology + economics +society

Summary
Use whatever label you wish … the makeup of our economy has changed. Information as a good and information technologies have replaced goods made of atoms and technologies resting on muscle.

Economics 101
Supply & Demand
Market Structure
Types of Goods
Network Effects
Examples/Discussion

What Is Economics?
Economics is the study of how people (and institutions) act in a society with limited resources (iow, scarcity)
The choices are more diverse than simply $$ - it’s also time, work, savings
Driving principle: that people optimize the “utility” (satisfaction) of goods and services consumed - that we are rational

John Kenneth Galbraith
“Faced with the choice between changing one’s mind or proving that there is no need to do so, almost everybody gets busy on the proof.”

Kuhnen & Knutson (2005)
Found that two brain areas known to be part of emotional processing (the limbic system) can help predict financial choices

Supply and Demand
Most widely used economic model
Describes how consumers and producers interact to determine the price of a good and the quantity that will be produced/sold

Demand Curve
Shows the quantity of a good (or service) that consumers are willing to buy at different prices
Assumes “all other things” remain constant (static)
Law of Demand: curve slopes “downward” (P on the vertical axis)

Supply Curve
Shows the quantity of a good (or service) that businesses are willing to sell at each price
Assumes “all other things” remain constant (static)
No “law of supply”

Supply-Demand

Competitive Markets (perfect competition)
No buyer or seller can influence price
Products and services are identical
No barriers to entry/exit
Everyone (consumer, worker, producer) has access to perfect information on prices and costs

Market Structure
Classic Free (Competitive) Market
Low fixed costs
Marginal cost = price … marginal cost is the cost of producing one additional unit
The “Natural” Monopoly
Large fixed costs
Small/zero marginal costs

Economics of Information
Costly to produce
Inexpensive to re-produce
Economist-speak:
High fixed costs, low marginal costs

Economics of Attention
Info overload: “a wealth of information creates a poverty of attention” (Herbert Simon)

Types of Goods (1/2)
Non-rival - a good that can be used by more than one person at the same time (an idea)
Non-excludable - it is not possible for the “owner” to exclude others from consuming this good (non-patented idea)

Types of Goods (2/2)
“ Public Goods”
Basic research
Defense, police, firemen
Lighthouse
“ Open” websites
TV (not cable!)
Public land
Most roads
Water - rivers, lakes
Non-Excludable
Trade secrets
Multi-license software
Patents
Subscription web sites
Most consumer goods
Private land
Services
Single license software
Excludable Non-Rival Rival

Excludability and Information
From the World Bank : Assume someone produces a valuable theorem, but it cannot be kept secret -- it must be made immediately available. Because anyone can immediately use it, there is no way for an individual to profit from creating it.

Types of Excludability (traditional)
Trade Secrets (Coca Cola)
Patents (Amazon One-Click)
Copyright
Will people create knowledge if they can’t charge for it? WB says No. Open source movement says Yes.

Digital Excludability (transitional?)
DRM
iTunes
Subscriptions
RealNetworks and Napster, The Economist and the WSJ
Lawsuits

An Experience Good
A good is an “experience” good if a consumer has to experience it to value it
Various biz strategies encourage “try before you buy”

Complementary Goods
CDs + CD Player
Websites “optimized” for a specific browser
Bluetooth headset & cellphone
Issues: network effects & lock-in

Network effects (1/2)
Static analysis:
One person’s decision to adopt a new piece of software (or other technology) has no effect on someone else’s welfare or decision to adopt
Assumes no network externality

Network effects (2/2)
Dynamic analysis:
The value of the software (or technology) depends upon the decisions of others (interoperability, for example)
Assumes there is a network externality

Locked In!
Consumers may be locked into a network because of “cost of exit” (switching)
Contracts (cell phone 24-month policies)
Training (learn a new system – ugh)
Data conversion (from Word to Word Perfect, for example)
Search cost (finding the new product)
Loyalty cost (frequent flyer programs, “minutes carry-over”)

Philosophy
Varian thinks it’s a good thing for firms to figure out how to create a lock as a way to improve the bottom line
I think that, at best, it’s a short-term strategy and that it is potentially harmful to society

Tipping
As market share increases for any one product (system, technology), there are increasing returns (externality) from increasing consumer demand, leading to dominance by one system

Examples
AM v FM radio
Beta v VHS
Mac v Windows
QWERTY v DVORAK
BlueRay v HD-DVD
GSM v CDMA

One More Point …
Time (fixed) + Info Explosion (overload?) = Increased competition for “old” media

Conclusion (1/2)
Economy is increasingly reliant on information technologies and information
Firms in this sector have a different cost structure than traditional goods/sectors like ag or manufacturing

Conclusion (2/2)
The products in this sector have characteristics of a public good -- the antithesis of a scarce, excludable good
Thus information technology is disruptive, economically and socially

For Wednesday
Post to your blog …. Reflection on this week’s readings AND reflection on your learning goals for the quarter. Categorize both posts “Reflection”

Next Assignments
3 July: post your scholarly article and a reflection on the assigned article
8 July: post your book review
10 July: post a reflection on someone else’s scholarly article
10 July: face-to-face meeting here

Lab
Demo “tagging”
Set Up Wordpress Blogs

Resources (1/3)
The Inkjet Printer, from The Economist. (2002) http: //emlab . berkeley .edu/users/bhhall/e124inkjetprinter.html
The Invention of Email, from Pretext Magazine (1998) http://emlab.berkeley.edu/users/bhhall/e124emailinvention.pdf
Hal R. Varian , “High Technology Industries and Market Structure” (2001) http://www. sims . berkeley . edu/~hal/Papers/structure/structure .html
Science and Engineering Indicators (2002) National Science Board. http://www.nsf.gov/sbe/srs/seind02/start.htm

Resources (2/3)
Michael L. Katz and Carl Shapiro. “Systems Competition and Network Effects,” Journal of Economic Perspectives , Vol 8 No 2 (1994)
Nicholas Economides. “The Economics of Networks,” International Journal of Industrial Organization, October (1996) http://www.stern.nyu.edu/networks/top.html
S.J. Liebowitz and Stephen E. Margolis. “Network Externality: An Uncommon Tragedy,” Journal of Economic Perspectives , Vol 8 No 2 (1994)

Resources (3/3)
Timothy F. Bresnahan. “The Economics of the Microsoft Case.” http://www. stanford . edu/~tbres/Microsoft/The_Economics_of_The_Microsoft_Case . pdf
Stephen Martin. “The Nature of Innovation Market Failure and the Design of Public Support for Private Innovation” http://www.sam.sdu.dk/undervis/92172.E03/martin_scott.pdf
Tore Nilssen and Lars Sørgard. “TV Advertising, Programming Investments, and Product-Market Oligopoly” http://www.nhh.no/sam/res-publ/2000/dp06.pdf

Economics of Digital Information

by Kathy Gill on Jul 02, 2008

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Economics of Digital Information — Presentation Transcript