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Economics of Digital Information


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Introductory lecture.

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Economics of Digital Information

  1. 1. Information, Markets and Society Kathy E. Gill 30 June 2008
  2. 2. Overview <ul><li>What is an Info Economy? </li></ul><ul><li>Economics 101 </li></ul><ul><ul><li>Types of goods </li></ul></ul><ul><ul><li>Network effects </li></ul></ul><ul><li>Examples and Discussion </li></ul>
  3. 3. But first …. <ul><li>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. </li></ul>Edward R. Murrow , 1958, RTNDA Convention
  4. 4. What Is An Info Economy? <ul><li>“ 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. </li></ul>
  5. 5. History of Term, Concept <ul><li>1963: Tadeo Umesao, Kyoto University, forecast an information industry </li></ul><ul><li>1973: Daniel Bell, Harvard, described a knowledge-based post-industrial economy </li></ul><ul><li>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. </li></ul>
  6. 6. Bell <ul><li>Post-industrial society will be “organized around knowledge for the purpose of social control and the directing of innovation and change” </li></ul><ul><li>The transformation is industrial to service </li></ul><ul><li>Anticipated tension between high-tech, intellectual work and nonprofessionals </li></ul>
  7. 7. Digital Expectations <ul><li>Personal anecdote about trying to read journal article, Blackwell Publishing (UK) </li></ul>
  8. 8. Today (almost!) <ul><li>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 </li></ul>
  9. 9. No Standard Nomenclature <ul><li>Info Economy, Post-Industrial Economy, “New” Economy? </li></ul><ul><li>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 </li></ul>
  10. 10. What is Information? <ul><li>In the context of this class, anything that can be converted to bits, ie, digitized, is an information good </li></ul><ul><ul><li>Entertainment </li></ul></ul><ul><ul><li>News </li></ul></ul><ul><ul><li>Business Info </li></ul></ul><ul><ul><li>Software </li></ul></ul>
  11. 11. What is Information Technology? <ul><li>Telecommunications, computers, software </li></ul><ul><ul><li>Communication: E-mail, IM, TheWeb </li></ul></ul><ul><ul><li>Networks: Extranet, Intranet, Internet, LAN, WAN </li></ul></ul><ul><ul><li>Software: Expert systems, Enterprise Resource Planning, Query and Reporting, Data Mining </li></ul></ul><ul><ul><li>Networks: T1, T3, Wireless </li></ul></ul><ul><ul><li>Protocols: HTTP, FTP, VoIP </li></ul></ul>
  12. 12. Societal Factors <ul><li>Demand for IT: </li></ul><ul><ul><li>Productivity? </li></ul></ul><ul><li>Effect of Growth: </li></ul><ul><ul><li>Collapse of space and time </li></ul></ul><ul><ul><li>Reduction of scarcity </li></ul></ul>
  13. 13. Competing Theories <ul><li>Technology optimists </li></ul><ul><ul><li>A new society without pollution; time for creative work; participatory democracy; perfect markets… </li></ul></ul><ul><li>Technology pessimists </li></ul><ul><ul><li>No new society but an increase the divide between rich and poor; greater control over individuals; erosion of privacy… </li></ul></ul><ul><li>Technology + economics +society </li></ul>
  14. 14. Summary <ul><li>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. </li></ul>
  15. 15. Economics 101 <ul><li>Supply & Demand </li></ul><ul><li>Market Structure </li></ul><ul><li>Types of Goods </li></ul><ul><li>Network Effects </li></ul><ul><li>Examples/Discussion </li></ul>
  16. 16. What Is Economics? <ul><li>Economics is the study of how people (and institutions) act in a society with limited resources (iow, scarcity) </li></ul><ul><ul><li>The choices are more diverse than simply $$ - it’s also time, work, savings </li></ul></ul><ul><ul><li>Driving principle: that people optimize the “utility” (satisfaction) of goods and services consumed - that we are rational </li></ul></ul>
  17. 17. John Kenneth Galbraith <ul><li>“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.” </li></ul>
  18. 18. Kuhnen & Knutson (2005) <ul><li>Found that two brain areas known to be part of emotional processing (the limbic system) can help predict financial choices </li></ul>
  19. 19. Supply and Demand <ul><li>Most widely used economic model </li></ul><ul><li>Describes how consumers and producers interact to determine the price of a good and the quantity that will be produced/sold </li></ul>
  20. 20. Demand Curve <ul><li>Shows the quantity of a good (or service) that consumers are willing to buy at different prices </li></ul><ul><li>Assumes “all other things” remain constant (static) </li></ul><ul><li>Law of Demand: curve slopes “downward” (P on the vertical axis) </li></ul>
  21. 21. Supply Curve <ul><li>Shows the quantity of a good (or service) that businesses are willing to sell at each price </li></ul><ul><li>Assumes “all other things” remain constant (static) </li></ul><ul><li>No “law of supply” </li></ul>
  22. 22. Supply-Demand
  23. 23. Competitive Markets (perfect competition) <ul><li>No buyer or seller can influence price </li></ul><ul><li>Products and services are identical </li></ul><ul><li>No barriers to entry/exit </li></ul><ul><li>Everyone (consumer, worker, producer) has access to perfect information on prices and costs </li></ul>
  24. 24. Market Structure <ul><li>Classic Free (Competitive) Market </li></ul><ul><ul><li>Low fixed costs </li></ul></ul><ul><ul><li>Marginal cost = price … marginal cost is the cost of producing one additional unit </li></ul></ul><ul><li>The “Natural” Monopoly </li></ul><ul><ul><li>Large fixed costs </li></ul></ul><ul><ul><li>Small/zero marginal costs </li></ul></ul>
  25. 25. Economics of Information <ul><li>Costly to produce </li></ul><ul><li>Inexpensive to re-produce </li></ul><ul><li>Economist-speak: </li></ul><ul><ul><li>High fixed costs, low marginal costs </li></ul></ul>
  26. 26. Economics of Attention <ul><li>Info overload: “a wealth of information creates a poverty of attention” (Herbert Simon) </li></ul>
  27. 27. Types of Goods (1/2) <ul><li>Non-rival - a good that can be used by more than one person at the same time (an idea) </li></ul><ul><li>Non-excludable - it is not possible for the “owner” to exclude others from consuming this good (non-patented idea) </li></ul>
  28. 28. Types of Goods (2/2) <ul><li>“ Public Goods” </li></ul><ul><li>Basic research </li></ul><ul><li>Defense, police, firemen </li></ul><ul><li>Lighthouse </li></ul><ul><li>“ Open” websites </li></ul><ul><li>TV (not cable!) </li></ul><ul><li>Public land </li></ul><ul><li>Most roads </li></ul><ul><li>Water - rivers, lakes </li></ul>Non-Excludable <ul><li>Trade secrets </li></ul><ul><li>Multi-license software </li></ul><ul><li>Patents </li></ul><ul><li>Subscription web sites </li></ul><ul><li>Most consumer goods </li></ul><ul><li>Private land </li></ul><ul><li>Services </li></ul><ul><li>Single license software </li></ul>Excludable Non-Rival Rival
  29. 29. Excludability and Information <ul><li>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. </li></ul>
  30. 30. Types of Excludability (traditional) <ul><li>Trade Secrets (Coca Cola) </li></ul><ul><li>Patents (Amazon One-Click) </li></ul><ul><li>Copyright </li></ul><ul><li>Will people create knowledge if they can’t charge for it? WB says No. Open source movement says Yes. </li></ul>
  31. 31. Digital Excludability (transitional?) <ul><li>DRM </li></ul><ul><ul><li>iTunes </li></ul></ul><ul><li>Subscriptions </li></ul><ul><ul><li>RealNetworks and Napster, The Economist and the WSJ </li></ul></ul><ul><li>Lawsuits </li></ul>
  32. 32. An Experience Good <ul><li>A good is an “experience” good if a consumer has to experience it to value it </li></ul><ul><ul><li>Various biz strategies encourage “try before you buy” </li></ul></ul>
  33. 33. Complementary Goods <ul><li>CDs + CD Player </li></ul><ul><li>Websites “optimized” for a specific browser </li></ul><ul><li>Bluetooth headset & cellphone </li></ul><ul><li>Issues: network effects & lock-in </li></ul>
  34. 34. Network effects (1/2) <ul><li>Static analysis: </li></ul><ul><ul><li>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 </li></ul></ul><ul><ul><li>Assumes no network externality </li></ul></ul>
  35. 35. Network effects (2/2) <ul><li>Dynamic analysis: </li></ul><ul><ul><li>The value of the software (or technology) depends upon the decisions of others (interoperability, for example) </li></ul></ul><ul><ul><li>Assumes there is a network externality </li></ul></ul>
  36. 36. Locked In! <ul><li>Consumers may be locked into a network because of “cost of exit” (switching) </li></ul><ul><ul><li>Contracts (cell phone 24-month policies) </li></ul></ul><ul><ul><li>Training (learn a new system – ugh) </li></ul></ul><ul><ul><li>Data conversion (from Word to Word Perfect, for example) </li></ul></ul><ul><ul><li>Search cost (finding the new product) </li></ul></ul><ul><ul><li>Loyalty cost (frequent flyer programs, “minutes carry-over”) </li></ul></ul>
  37. 37. Philosophy <ul><li>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 </li></ul><ul><li>I think that, at best, it’s a short-term strategy and that it is potentially harmful to society </li></ul>
  38. 38. Tipping <ul><li>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 </li></ul>
  39. 39. Examples <ul><li>AM v FM radio </li></ul><ul><li>Beta v VHS </li></ul><ul><li>Mac v Windows </li></ul><ul><li>QWERTY v DVORAK </li></ul><ul><li>BlueRay v HD-DVD </li></ul><ul><li>GSM v CDMA </li></ul>
  40. 40. One More Point … <ul><li>Time (fixed) + Info Explosion (overload?) = Increased competition for “old” media </li></ul>
  41. 41. Conclusion (1/2) <ul><li>Economy is increasingly reliant on information technologies and information </li></ul><ul><li>Firms in this sector have a different cost structure than traditional goods/sectors like ag or manufacturing </li></ul>
  42. 42. Conclusion (2/2) <ul><li>The products in this sector have characteristics of a public good -- the antithesis of a scarce, excludable good </li></ul><ul><li>Thus information technology is disruptive, economically and socially </li></ul>
  43. 43. For Wednesday <ul><li>Post to your blog …. Reflection on this week’s readings AND reflection on your learning goals for the quarter. Categorize both posts “Reflection” </li></ul>
  44. 44. Next Assignments <ul><li>3 July: post your scholarly article and a reflection on the assigned article </li></ul><ul><li>8 July: post your book review </li></ul><ul><li>10 July: post a reflection on someone else’s scholarly article </li></ul><ul><li>10 July: face-to-face meeting here </li></ul>
  45. 45. Lab <ul><li>Demo “tagging” </li></ul><ul><li>Set Up Wordpress Blogs </li></ul>
  46. 46. Resources (1/3) <ul><li>The Inkjet Printer, from The Economist. (2002) http: //emlab . berkeley .edu/users/bhhall/e124inkjetprinter.html </li></ul><ul><li>The Invention of Email, from Pretext Magazine (1998) </li></ul><ul><li>Hal R. Varian , “High Technology Industries and Market Structure” (2001) http://www. sims . berkeley . edu/~hal/Papers/structure/structure .html </li></ul><ul><li>Science and Engineering Indicators (2002) National Science Board. </li></ul>
  47. 47. Resources (2/3) <ul><li>Michael L. Katz and Carl Shapiro. “Systems Competition and Network Effects,” Journal of Economic Perspectives , Vol 8 No 2 (1994) </li></ul><ul><li>Nicholas Economides. “The Economics of Networks,” International Journal of Industrial Organization, October (1996) </li></ul><ul><li>S.J. Liebowitz and Stephen E. Margolis. “Network Externality: An Uncommon Tragedy,” Journal of Economic Perspectives , Vol 8 No 2 (1994) </li></ul>
  48. 48. Resources (3/3) <ul><li>Timothy F. Bresnahan. “The Economics of the Microsoft Case.” http://www. stanford . edu/~tbres/Microsoft/The_Economics_of_The_Microsoft_Case . pdf </li></ul><ul><li>Stephen Martin. “The Nature of Innovation Market Failure and the Design of Public Support for Private Innovation” </li></ul><ul><li>Tore Nilssen and Lars Sørgard. “TV Advertising, Programming Investments, and Product-Market Oligopoly” </li></ul>