Economics of Information and Communication ITC: 230 Indra K Maharjan ME / MBS [email protected].

Economics of Economics of Information and Information and CommunicationCommunication

ITC: 230ITC: 230

Indra K MaharjanIndra K Maharjan

ME / MBSME / MBS

[email protected]@gmail.com

Part I: Managerial Economics BasicChapter: 1 (Notes and Handouts)

Part II: The Information EconomyChapter: 2- 9 (Carl Shapiro and Hal R. Varian. Information Rules: A Strategic Guide for the Network Economy)

Part III: The New EconomyChapter: 10, 11 (Notes and Handouts)

“ “Economics of Information" is a Economics of Information" is a phrase that means different phrase that means different things to different people. things to different people. Information plays a role in all Information plays a role in all markets. markets. The simplest kind of market The simplest kind of market theory does not apply, and theory does not apply, and markets may not be as effective.markets may not be as effective.

IntroductionIntroduction

Some organizations and enterprises Some organizations and enterprises exist mainly for the purpose of exist mainly for the purpose of supplying information goods and supplying information goods and services.services. Typical questions of Typical questions of microeconomics.microeconomics.

1) Have information products 1) Have information products any special characteristics that set any special characteristics that set them apart, economically, from other them apart, economically, from other kinds of products and services? kinds of products and services?

2) If so, what characteristics? 2) If so, what characteristics?

IntroductionIntroduction

3) What sort of markets are markets 3) What sort of markets are markets for information goods? Are they for information goods? Are they "competitive," in the sense of economic "competitive," in the sense of economic theory, or are there elements of theory, or are there elements of monopoly?monopoly?

4) Does a market equilibrium in 4) Does a market equilibrium in information markets correspond to an information markets correspond to an efficient output, or would it be more efficient output, or would it be more efficient if the output were increased (or efficient if the output were increased (or decreased) by comparison with the market decreased) by comparison with the market equilibrium? equilibrium?

IntroductionIntroduction

A newly invented machine is A newly invented machine is patented, and the patent is licensed patented, and the patent is licensed to a company that plans to build and to a company that plans to build and sell the machine. sell the machine. A new edition of a best-selling A new edition of a best-selling travel guide is published. travel guide is published. A public library buys 3 copies of the A public library buys 3 copies of the travel guide to lend (free) to its travel guide to lend (free) to its patrons. patrons.

What is this stuff, What is this stuff, "information?""information?"

A financial advisor offers his clients A financial advisor offers his clients advice and opinions about profitable advice and opinions about profitable investments in return for a commission on investments in return for a commission on their investment transactions. their investment transactions. An investor consults a World-Wide Web An investor consults a World-Wide Web page for the values of "leading economic page for the values of "leading economic indicators" (key economic statistics) indicators" (key economic statistics) supplied by the U. S. Commerce supplied by the U. S. Commerce Department. There is no charge. Department. There is no charge. A collection of photographs of great A collection of photographs of great paintings in world museums is put on CD-paintings in world museums is put on CD-ROM and sold by a computer software ROM and sold by a computer software company. company.

What is this stuff, What is this stuff, "information?""information?"

a)a) An information product is a An information product is a collection of symbols.collection of symbols.

b)b) Its utility depends on the Its utility depends on the arrangement of the symbols, not arrangement of the symbols, not on the material form that they on the material form that they take. take.

PropertiesProperties

Distinctive economic and Distinctive economic and organizational characteristics of organizational characteristics of information products:information products:

Media of Transmission Media of Transmission Uniqueness Uniqueness High Fixed Costs High Fixed Costs The Incentive Problem The Incentive Problem Intellectual PropertyIntellectual Property

PropertiesProperties

They cannot be sold alone They cannot be sold alone but only jointly with some but only jointly with some medium of communicationmedium of communication. .

Media of TransmissionMedia of Transmission

Each such product is Each such product is unique. Information unique. Information products are not products are not homogenous. homogenous.

Uniqueness Uniqueness

Fixed costs for such Fixed costs for such products are high, since products are high, since only the costs of the only the costs of the medium of communication medium of communication are variable (and perhaps are variable (and perhaps not all of them) not all of them)

High Fixed CostsHigh Fixed Costs

Because they are easily Because they are easily and cheaply imitated, and cheaply imitated, there may be a problem there may be a problem of insufficient incentive of insufficient incentive to produce information to produce information products. products.

The Incentive Problem The Incentive Problem

Intellectual property Intellectual property rights are instituted in rights are instituted in some cases to provide some cases to provide incentives that would incentives that would otherwise be missing. otherwise be missing.

Intellectual PropertyIntellectual Property

The characteristics of information The characteristics of information products differ in important ways products differ in important ways from those of goods traded in from those of goods traded in "perfect" (p-competitive) markets "perfect" (p-competitive) markets but may, in fact, be approximated but may, in fact, be approximated by the cases of monopoly in some by the cases of monopoly in some cases and of public goods in other cases and of public goods in other cases cases

PropertiesProperties

The characteristics of information The characteristics of information products differ in important ways products differ in important ways from those of goods traded in from those of goods traded in "perfect" (p-competitive) markets "perfect" (p-competitive) markets but may, in fact, be approximated but may, in fact, be approximated by the cases of monopoly in some by the cases of monopoly in some cases and of public goods in other cases and of public goods in other cases cases

PropertiesProperties

Information products are thus Information products are thus quasi-public goods, and in quasi-public goods, and in extreme cases may be public extreme cases may be public goods. goods.

Profit-oriented private supply is Profit-oriented private supply is very unlikely, and government very unlikely, and government provision may be the only provision may be the only alternative to doing without. Adam alternative to doing without. Adam Smith's lighthouse is an instance Smith's lighthouse is an instance of this. of this.

PropertiesProperties

Late 1990s: Late 1990s: “Combinatorial “Combinatorial Innovation.'' Innovation.''

Every now and then a technology, or Every now and then a technology, or set of technologies, comes along that set of technologies, comes along that offers a rich set of components that can offers a rich set of components that can be combined and recombined to create be combined and recombined to create new products. The arrival of these new products. The arrival of these components then sets off a technology components then sets off a technology boom as innovators work through the boom as innovators work through the possibilities. possibilities.

The Internet BoomThe Internet Boom

Attempts to develop Attempts to develop interchangeable parts during the interchangeable parts during the early nineteenth century : gears, early nineteenth century : gears, pullies, chains, cams etc.pullies, chains, cams etc.

Development of the gasoline Development of the gasoline engine .engine .

Combinatorial InnovationCombinatorial Innovation

(Shumpeter [2000]), (Shumpeter [2000]), combinatorial innovation is combinatorial innovation is one of the important one of the important reasons why inventions reasons why inventions appear in waves, or appear in waves, or ``clusters,''. ``clusters,''.

Combinatorial InnovationCombinatorial Innovation

After various kinds of social After various kinds of social resistance to something that is resistance to something that is fundamentally new and untried fundamentally new and untried have been overcomed, it is much have been overcomed, it is much easier not only to do the same easier not only to do the same thing again but also to do thing again but also to do similar similar things in different directions, so things in different directions, so that a first success will always that a first success will always produce a cluster.produce a cluster.

Combinatorial InnovationCombinatorial Innovation

““demand-side'‘ and “supply-side'': demand-side'‘ and “supply-side'': since innovators are, in many since innovators are, in many cases, working with the same cases, working with the same components, it is not surprising to components, it is not surprising to see simultaneous innovation, with see simultaneous innovation, with several innovators coming up with several innovators coming up with essentially the same invention at essentially the same invention at almost the same time. almost the same time.

Combinatorial InnovationCombinatorial Innovation

Development of complements. Development of complements. The routers that laid the The routers that laid the

groundwork for the Internet, the groundwork for the Internet, the servers that dished up servers that dished up information, and the computers information, and the computers that individuals used to access that individuals used to access this information were all enabled this information were all enabled by the microprocessor. by the microprocessor.

Combinatorial InnovationCombinatorial Innovation

But the Internet But the Internet revolution took only a revolution took only a few years. Why was it few years. Why was it so rapid compared to so rapid compared to the others? the others?

One hypothesis is that One hypothesis is that the Internet revolution the Internet revolution was minor compared to was minor compared to the great technological the great technological developments of the developments of the past.past.

The component parts of the The component parts of the Internet revolution were Internet revolution were quite different from the quite different from the mechanical or electrical mechanical or electrical devices that drove previous devices that drove previous periods of combinatorial periods of combinatorial growth. growth.

The components of the The components of the Internet revolution were not Internet revolution were not physical devices as all. Instead physical devices as all. Instead they were ``just bits.'' They they were ``just bits.'' They were ideas, standards were ideas, standards specifications, protocols, specifications, protocols, programming languages, and programming languages, and software. software.

No delays to manufacturer, or No delays to manufacturer, or shipping costs, or inventory shipping costs, or inventory problems,. problems,.

Quiet phase of Quiet phase of combinatorial innovation: combinatorial innovation: the components have been the components have been perfected, the initial perfected, the initial inventions have been inventions have been made, but they have not made, but they have not yet been fully incorporated yet been fully incorporated into organizational work into organizational work practices. practices.

Where are we now? Where are we now?

We need a new economics to We need a new economics to understand the new economy understand the new economy of bits.of bits.

Effects that were uncommon Effects that were uncommon in the industrial economy-like in the industrial economy-like network effects, switching network effects, switching costs, and the like-are the costs, and the like-are the norm in the information norm in the information economy economy

The “New Economy'' The “New Economy''

Personalization of products and Personalization of products and prices, prices,

VersioningVersioning BundlingBundling Switching costsSwitching costs Lock-inLock-in Economies of scaleEconomies of scale Network effectsNetwork effects Standards, and systems effects. Standards, and systems effects.

The “New Economy'' The “New Economy''

References:References:(Carl Shapiro and Hal R.

Varian. Information Rules: A Strategic Guide for the

Network Economy)