Economics of Digital Information

Information, Markets and SocietyInformation, Markets and Society

Kathy E. Gill30 June 2008Kathy E. Gill30 June 2008

30 June 2008 COM597 - Gill

OverviewOverview

What is an Info Economy? Economics 101

Types of goods Network effects

Examples and Discussion

What is an Info Economy? Economics 101

Types of goods Network effects

Examples and Discussion


But first ….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.

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?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.

“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, ConceptHistory 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.

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.


BellBell 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

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

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


Today (almost!)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

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 NomenclatureNo 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

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?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

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?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

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 FactorsSocietal Factors Demand for IT:

Productivity? Effect of Growth:

Collapse of space and time Reduction of scarcity

Demand for IT: Productivity?

Effect of Growth: Collapse of space and time Reduction of scarcity


Competing TheoriesCompeting 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

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 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.

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

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


What Is Economics?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

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 GalbraithJohn 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.”

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

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


Supply and DemandSupply 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

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 CurveDemand 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)

Shows the quantity of a good (or service) that consumers are willing to buy at different prices


Law of Demand: curve slopes “downward” (P on the vertical axis)


Supply CurveSupply Curve Shows the quantity of a good (or service) that businesses are willing to sell at each price


No “law of supply”

Shows the quantity of a good (or service) that businesses are willing to sell at each price


No “law of supply”


Supply-DemandSupply-Demand


Competitive Markets (perfect competition)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

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 StructureMarket 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

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 InformationEconomics of Information Costly to produce Inexpensive to re-produce Economist-speak:

High fixed costs, low marginal costs

Costly to produce Inexpensive to re-produce Economist-speak:

High fixed costs, low marginal costs


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

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


Types of Goods (1/2)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)

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)Types of Goods (2/2)

Rival Non-Rival

Excludable

• Most consumer goods• Private land• Services• Single license software

• Trade secrets• Multi-license software• Patents• Subscription web sites

Non-Excludable

• Public land• Most roads• Water - rivers, lakes

• “Public Goods”• Basic research• Defense, police, firemen• Lighthouse• “Open” websites• TV (not cable!)


Excludability and InformationExcludability 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.

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)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.

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?)Digital Excludability (transitional?)

DRM iTunes

Subscriptions RealNetworks and Napster, The Economist and the WSJ

Lawsuits

DRM iTunes

Subscriptions RealNetworks and Napster, The Economist and the WSJ

Lawsuits


An Experience GoodAn 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”

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 GoodsComplementary Goods CDs + CD Player Websites “optimized” for a specific browser

Bluetooth headset & cellphone Issues: network effects & lock-in

CDs + CD Player Websites “optimized” for a specific browser

Bluetooth headset & cellphone Issues: network effects & lock-in


Network effects (1/2)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

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

http://are.berkeley.edu/courses/ECON100A/lectures/lec18t.pdf

http://are.berkeley.edu/courses/ECON100A/lectures/lec18t.pdf


Network effects (2/2)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

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!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”)

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”)


PhilosophyPhilosophy 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

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


TippingTipping 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

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

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


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

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


Conclusion (1/2)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

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)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

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

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


Next AssignmentsNext 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

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


LabLab Demo “tagging” Set Up Wordpress Blogs

Demo “tagging” Set Up Wordpress Blogs


Resources (1/3)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

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

http://emlab.berkeley.edu/users/bhhall/e124inkjetprinter.html












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)

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)



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

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

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