Economics and Electronic Commerce

The Competitive Benchmark

• Firms are small, production processes are simple, inputs are readily available and not specialized to any specific firm’s production process.

• All goods --inputs and outputs -- are commodities. There is no branding or product differentiation.

• All markets are perfectly competitive. No firm’s individual production or procurement decisions affect market prices. No individual consumer’s purchases affect market prices.

Competitive Benchmark

• Cost curves are U-shaped, with constant returns to scale prevailing in the long-run.

• P=MC=min LRATC• The competitive equilibrium is efficient: no

reallocation of resources can make any individual better off without making someone else worse off.

The Contemporary Economic Landscape

• Firms are large, production is complex, inputs are specialized.

• Average cost declines, with significant increasing returns to scale.

• Firms enjoy significant market power: oligopoly.• Extensive product differentiation and marketing.

The Imperatives of Technology

• Applications of technology require precise subdivision and coordination of activities.

• Large-scale subdivision generates complexity which must be comprehended and managed.

• Complexity extends production processes in time and space.– Spatial extension through the supply chain

– Temporal extension through component fabrication and assembly

The Imperatives of Technology

• Microeconomic Consequences:– Large overhead costs.– Significant economies of scale and scope.– Multi-dimensional product characteristics.

• Consequences for Industrial Organization – Strategic rather than competitive environment.– Non-price competition (branding and product

differentiation).

Information and the Economic Landscape

• What is the role of information in the economic landscape?

• The Hayek model: Competitive paradigm – Prices are sufficient statistics for information about the

state of the market.

– Competitive markets aggregate economic information.

– Decentralized decision-making requires only prices as inputs to decision processes.

Information and the Economic Landscape

• Strategic distortions of the competitive model:– Information is internalized in the supply chain and

through long-term contracting relationships between firms.

– Market segmentation and price discrimination mask information content of prices.

– Product differentiation fragments information.

– Strategic interactions (pricing and marketing) entangle information through versioning and bundling decisions.

The Internet and the New Economy

• Information technology is simultaneously intensifying the strategic features of the economic landscape, while making it more competitive.– Strategic Intensification

• Greater scope for both B2B and B2C commercial interactions

• Tightening of existing supply chains through internet data transfer protocols

• Dis- and re-intermediation of consumer sales.

The Internet and the New Economy

– Intensification of competition• Digital goods and services are the most extreme examples of

the technological imperative: All costs are fixed costs -- marginal cost is zero.

• Wide-spread adoption of information technology puts zero cost production (copying) capabilities in everyone’s hands.

• Wide-spread adoption of technology gives economic agents vastly expanded access to information about products and prices.

Plan For the Course

• We will focus first on digital goods and services, examining issues of– Pricing and Market Structure

– Economics Rights Management

– Externalities and Standards

– Regulation

• Our methodology for examining these issues will involve real-time market experiments, analysis of economic models, and real world examples.

Plan for the Course

• Time permitting, we will then use the insights developed in this section to examine how the internet if affecting commerce more broadly, looking at issues of:– Search– Supply Chain Management– Intermediation– Demand Management