Economics of Information and Internet

(pdf version)

1 Description

This unit deals with the economics of the production and distribution of information
goods on the Internet. We analyse the production, pricing and distribution of products
that are mainly informational in nature, such as software and news. We also study the
structure and functioning of Internet-mediated markets, as well as models of production
that are specific to the Internet.

Lectures (2 hrs/week)

Lectures are based both on the analysis of the activities of existing Internet companies
and on the study of related theoretical and empirical economic literature. We study four
main topics, as follows:

  1. How producers of information goods price and market their products.
  2. The ways in which consumers search for goods and information online, and how
    information about consumers is used by firms.
  3. The business of intermediaries such as Amazon and Google that put buyers and
    sellers in contact on the Internet.
  4. Software development and the emergence of new models of collaboration online.

Exercises (2 hrs/week)

Exercises will focus on analyzing specific aspects of the strategies of a range of Internet
companies, as explained in recent published academic articles. We will study articles
from the reading list and write up our own case study of the Internet strategy of an
existing firm. Finally, we will train for the final exam.

2 Recommended book

“Information Rules: A Strategic Guide to the Network Economy.” By Carl Shapiro
and Hal Varian, 1999, Harvard Business School Press. (“Shapiro & Varian”
hereafter)

Note that the first chapters of this books are available as a sample online. The
book is very cheaply available to buy online as well.

3 Evaluation

Final Exam: 90mn, consisting in a mix of knowledge and reflection questions (see
mockup exam and exam from last year).

4 Language

Lectures and exercises will be in English.

5 Dates & Locations

  1. Lectures: Wednesdays, 10:00 – 12:00, weekly (from 24.10.2018) Location: Raum
    0.168, Gebaeude Oeconomicum, Pl. d. Göttinger Sieben 3
  2. Exercises: Thursdays, 16:00 – 18:00, weekly (from 25.10.2018) Location: Raum
    0.168, Gebaeude Oeconomicum, Pl. d. Göttinger Sieben 3
  3. Exam: Wednesday 13.02.2019, 10.00 – 12.00, Raum ZHG 003, Gebaeude ZHG: Pl. d.
    Göttinger Sieben 5

6 Outline

6.1 Introduction, context, definitions, goals and structure of the course

We speak about the meaning and importance of the “Information Revolution” and the
changes it has generated in the organisation of economic activities. In particular, we
discuss the impact of the Internet on productivity. We also give examples of Internet
business models.

  • Brynjolfsson, E., & Hitt, L. M. (2000). Beyond Computation: Information
    Technology, Organizational Transformation and Business Performance. Journal of
    Economic Perspectives, 14(4), 23–48. https://doi.org/10.1257/jep.14.4.23

Exercise: We read an article in the Economist to understand how the Information
revolution is based on better collection and use of data about economic activity.

6.2 Definitions and economic issues with information goods

In this part, we define the economic characteristics of information goods and also discuss
how consumers search for good online. We underline the issue of asymmetric information that is particularly prevalent between buyer and seller on the Internet.

Keywords: Fixed and marginal costs, non-rivalry, excludability, reproducibility, private
and public goods, search, credence and experience goods. Informational asymmetry,
the issue with lemons.

  • Ch. 1 Shapiro & Varian

Exercise: We read an academic article about how to model search for information about
a product and discuss the benefits of better search facilities for consumers online.

  1. “Hidden in the long tail.” (January 8, 2015). The Economist.
    https://www.economist.com/finance-and-economics/2015/01/08/hidden-in-the-longtail
  2. Nelson, P. (1970). Information and Consumer Behavior. Journal of Political
    Economy, 78(2), 311-329. http://www.jstor.org/stable/1830691

6.3 Pricing information goods

Information goods can be combined together in many different ways at little cost. We
study different ways in which information goods can be packaged for sale and we discuss how information about consumers can help firms extract a higher share of the economic surplus generated by their activity.

Keywords: bundling, versioning, subscription vs. per-use fees.

  • Ch. 2 and 3 Shapiro & Varian

Exercise: We discuss and compare two papers about bundling information goods, in
theory and in practice.

  1. Bakos, Y., & Brynjolfsson, E. (1999). Bundling Information Goods: Pricing, Profits,
    and Efficiency. Management Science, 45(12), 1613-1630.
    http://www.jstor.org/stable/2634781
  2. “Product Bundling is a Smart Strategy — But There’s a Catch.”, January 2013,
    Forbes, https://www.forbes.com/sites/hbsworkingknowledge/2013/01/18/productbundling-
    is-a-smart-strategy-but-theres-a-catch/

6.4 Marketing information goods

Internet makes it easy for consumer to find products online, but it is still difficult to judge of their quality and there is an issue of trust between buyers and sellers. We consider the role of intermediaries such as Amazon in giving information about goods, certifying their quality and facilitating search by consumers. We conclude with a case-study of Amazon.

Keywords: expert recommendations, product ratings, repeat buying, certification,
guarantees, samples (demos), reputation.

  • Lizzeri, A. (1999). Information Revelation and Certification Intermediaries. The
    RAND Journal of Economics, 30(2), 214-231. http://doi.org/10.2307/2556078

Exercise: We read a case study of Amazon, mainly to learn about the history and
business of Amazon and think about writing our own case study of an Internet
business.

6.5 Internet auctions and advertising

We are used to buy products for a set price and not to bargain. This was not always so,
and many prices are not set that way. We discuss the use of auctions to sell goods on eBay
and to sell advertising on Google. We consider the problem of balancing the interests of
buyers and sellers on both those platforms: How do eBay and Google manage to keep
both of them satisfied?

Keywords: first price, second price auctions, the winner’s curse, advertising placement
on search engine

Exercise: We consider Facebook’s advertising system and how it is used by small
companies but also political actors to target consumers and citizens.

  1. Helm B. (2017). “How Facebook’s Oracular Algorithm Determines the Fates of
    Start-Up”, The New York Times, https://www.nytimes.com/2017/11/02/magazine/how-Facebooks-oracular-algorithmdetermines-the-fates-of-start-ups.html
  2. “Once considered a boon to democracy, social media have started to look like its
    nemesis.” (2017, November 4). The Economist.  https://www.economist.com/briefing/2017/11/04/once-considered-a-boon-todemocracy-social-media-have-started-to-look-like-its-nemesis

6.6 Network effects

Network effects are a subjects that we study over two weeks because of their importance. We consider the role of network effects in driving market concentration and
standardization. We also discuss how companies can manage to break out of existing
standards to launch better ones.

Keywords: compatibility, critical mass, coordination, bandwagon effect, lock-in, winner
takes all, switching costs, standards.

  1.  Ch. 7 Shapiro & Varian
  2.  Katz, M. L., & Shapiro, C. (1985). Network Externalities, Competition, and Compatibility. The American Economic Review, 75(3), 424-440. http://www.jstor.org/stable/1814809
  3.  Shapiro, C., & Varian, H. R. (1999). The Art of StandardsWars. California Management Review, 41(2), 8-32. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=1671231&site=ehostlive

Exercise 1: We consider and illustrate how network effects come into play for Internet
marketplaces, online newspapers, and social networking sites. In particular, we
chart the growth and decline of a series of social networking sites over time.

Exercise 2: We discuss how to identify network effects, based on an historical study of
the emergence of standards for keyboard letter configurations.

  • The QWERTY myth. (1999, April). The Economist. http://www.economist.com/node/196071

6.7 Two-sided markets

This part is a complement to the part on network effects, where we underline how
intermediaries in Internet markets have to deal with network effects on two sides of their business. For example buyers benefit from the presence of more sellers on eBay, but suffer from the presence of other buyers, with whom they have to compete.

Keywords: intermediaries, externalities, chicken and egg, divide and conquer,
cross-subsidies

  • Part 1 of “Matchmakers: The New Economics of Multisided Platforms” By David
    Evans and Richard Schmalensee, 2016. Harvard Business Review Press,
    http://matchmakereconomics.com. (Note that part 1 is available for free online.)

Exercise: We consider how print newspapers in the US reacted to lower number of
readers and reduced revenues from advertising by increasing prices for readers.

  • Pattabhiramaiah, A., Sriram, S., & Sridhar, S. (2017). Rising Prices Under
    Declining Preferences: The Case of the U.S. Print Newspaper Industry. Marketing
    Science, 37(1), 97–122. https://doi.org/10.1287/mksc.2017.1060

6.8 Big data, consumer targeting and privacy

Internet firms have access to a wealth of information about the identity and behavior of
their customers. Most consumers do not seem to be aware or bothered by this, but recent
scandals have underlined the need for regulation of the trade of private personal data on
the Internet. We study the issue from a behavioral and regulatory standpoint.

Keywords: Consumer targeting, advertising, personalisation, personal information

Exercise: We read an article and discuss the way in which new regulations about the
use of private data by companies are getting introduced in the US and in Europe.
We also go deeper into what the European Union’s General Data Protection Regulation means for consumers and firms.

6.9 Open-source development , software design and licensing

The Internet does not only change how products are marketed, but also how information
products are being developed. Open-source software methods of production provide a
unique insight into how software is developed by teams of developers in a transparent
and open way. We discuss whether other information products can also be produced in
this way.

Keywords: public good, private development of public goods, copyright, interfaces,
testing, documentation, interfaces, code re-use and maintenance, copyleft, signaling,
commons, free software, BSD license, GPL, proprietary, public domain

  1. Chapter 1 of “The Success of Open Source.” By Stefan Weber, 2004. Harvard
    University Press.
  2. Lerner, J., & Tirole, J. (2002). Some Simple Economics of Open Source. The Journal of Industrial Economics, 50(2), 197-234. http://doi.org/10.1111/1467-6451.00174

Exercise: We read an article by Richard Stallman, one of the original driving forces
behind the development of free software. The issue is of defining what the
philosophy of free / open source software really is; is it merely a software
development methodology, or is it about building software that anyone can adapt to
their own needs?

  1. “What is free software? The Free Software Definition”, https://www.gnu.org/philosophy/free-sw.html
  2. Richard Stallman (2007): “Why Open Source misses the point of Free Software”,
    https://www.gnu.org/philosophy/open-source-misses-the-point.en.html

6.10 Wrap-up: What did we learn, what did we forget, and what didn’t we understand?

In the last session, we go back on what we learned during this course, we clarify issues
and address possible misunderstandings. We also go over exams from past years and
train in answering questions in a complete and structured way.