Mod 1
• Useful Concepts
• Information goods and Review of some
economic concepts.
Lecture 1
Information (Knowledge)Goods
•
•
•
All products contain some degree of
information.
It is generally believed, and probably true,
that modern products contain a higher
degree of information and smaller
component of physical inputs than older
products.
The Internet Economy is particularly
suited to the transmission of information
goods.
Some Useful Economic Concepts
• Elasticity
• Price Discrimination
• Public (Information) Goods
• Reproducing Information Goods
• Natural Monopoly
Price Elasticity Of Demand
• def: percentage change in quantity divided
by percentage change in price
• (ΔQ/Q)/(ΔP/P) or (ΔQ/ΔP) (P/Q)
• measure of responsiveness
a.
b.
c.
d.
If Elasticity is >1 known as elastic (responsive
customers)
If Elasticity is =1 ; unit elastic
If Elasticity is <1; inelastic (less responsive
customers)
Infinite and zero elasticity
Illustrations of elasticity
D with zero elasticity
P
D with infinite elasticity
Q
Elasticity and TR
•
•
•
When elasticity is greater than 1 (elastic)
increases in price lead to decreases in
revenue and vice-versa
When elasticity is equal to 1, changes in
price lead to no change in revenues
When elasticity is less than 1 (inelastic)
increases in price lead to increases in
revenue.
Implications of Elasticity
•
•
•
•
•
If Elasticity is <1, firm can always increase
Profit by increasing price (revenues increase and
costs decrease because output decreases)
If Elasticity =1, firm can always increase profit
by increasing price
If Elasticity>1 firm can not necessarily increase
its profits by a change in price.
Thus firms that maximize profits must have
elasticities >1.
Example of VideoTape Sales Demonstrates
Importance of knowing elasticity.
Why is Windows so Cheap?
• Elasticity indicates that Windows is grossly
underpriced relative to short run monopoly
price.
T a b le 1
W in d o w 's
s h a re o f
to ta l c o s t
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
65%
70%
75%
80%
85%
90%
Im p a c t o f a 1 %
R e q u ir e d % d e c r e a s e
M in u m u m d e c r e a s e in c o m p u te r
in c r e a s e in th e in n u m b e r o f c o m p u te r s p u r c h a s e s b r o u g h t a b o u t b y a 1 %
p r ic e o f W in d o w s
s o ld to m a k e th e
p r ic e r is e in c o m p u te r s th a t w o u ld
o n th e p r ic e o f a
in c r e a s e d W in d o w s
c a u s e a W in d o w s p r ic e in c r e a s e to
c o m p u te r
p r ic e u n p r o f ita b le
b e u n p r o f ita b le
0 .0 5 %
0 .9 9 0 %
1 9 .8 %
0 .1 0 %
0 .9 9 0 %
9 .9 %
0 .1 5 %
0 .9 9 0 %
6 .6 %
0 .2 0 %
0 .9 9 0 %
5 .0 %
0 .2 5 %
0 .9 9 0 %
4 .0 %
0 .3 0 %
0 .9 9 0 %
3 .3 %
0 .3 5 %
0 .9 9 0 %
2 .8 %
0 .4 0 %
0 .9 9 0 %
2 .5 %
0 .4 5 %
0 .9 9 0 %
2 .2 %
0 .5 0 %
0 .9 9 0 %
2 .0 %
0 .5 5 %
0 .9 9 0 %
1 .8 %
0 .6 0 %
0 .9 9 0 %
1 .7 %
0 .6 5 %
0 .9 9 0 %
1 .5 %
0 .7 0 %
0 .9 9 0 %
1 .4 %
0 .7 5 %
0 .9 9 0 %
1 .3 %
0 .8 0 %
0 .9 9 0 %
1 .2 %
0 .8 5 %
0 .9 9 0 %
1 .2 %
0 .9 0 %
0 .9 9 0 %
1 .1 %
Consumer and Producer Surplus
• Consumer surplus is the difference between
the price paid and the higher price that
consumers would have been willing to pay
for the product.
• Producer surplus is the difference between
the payment received and the minimum
payment that producers would have
accepted.
Consumer and Producer Surplus
P1
1
3
Pe
4
2
Q1
CS = 1
PS = 2
Qe
DWL = 3+4
Monopoly Vs. Competition
•
Monopoly versus competition (smaller q, higher p)
•
Imposing a tax on a monopolist similar to competition in
that producer still bears part of it.
•
Price controls and monopoly ...a case where controls
may increase efficiency.
•
Price discrimination.
•
The tradeoff associated with patents and copyright deadweight loss in consumption versus possible new
products.
Monopoly charges higher price, produces smaller quantity.
Monopoly causes Deadweight Loss 1+2. Area 3+4 is transfer to producer from
consumer
MC
S
Pm
3
Pc
4
1
2
D
Qm
Qc
MR
Natural Monopoly
• Downward sloping AC curve.
• More efficient to have 1 large firm than
many small firms.
• Rate of return regulation is how we regulate
these firms.
• Removes incentive to keep costs down.
Natural Monopoly
Pm
Unregulated Profit
Pr
Losses with efficient output
PE
AC
MC
Qm Qr
QE
Lecture 2
Price Discrimination
• Perfect
• Two or More Markets
• Bundling and Block Booking
• Versioning
Perfect Price Discrimination
•
•
•
•
•
•
Theoretical ideal. Cannot be fully achieved.
Find maximum price that every consumer is
willing to pay and charge them that price.
Requires more information than any firm has,
and the prevention of arbitrage.
Demand Curve becomes MR curve.
No Deadweight Loss.
Approximate examples: automobile dealers,
doctors in the old days.
19
Perfect Price Discrimination.
P1
S
P3
P6
D
Qo
Declining Price Schedule
• Also true for ‘all-or-nothing’ pricing.
Price Discrimination - 2 or more Markets
•
•
•
•
•
If markets for a single product have
different MRs, profits can be increased by
shifting output from low MR markets to
high MR markets.
Raise price in low MR market and lower
price in high MR market.
High MR market is high elasticity market.
Need to Prevent Arbitrage.
Examples: Airlines with business travelers
and vacationers. Coupons.
Market 2
Market 1
P1
price before discrimination
P2
D
mr2
D
mr
Q2
Q1
mr1
MR
MR
Price Discrimination Rules
•
•
•
•
Raise price in market with lower elasticity
(lower responsiveness)
Lower price in market with higher elasticity.
Do this until MRs are equalized. But prices will
not be equalized.
Examples: Airlines with business travelers and
vacationers.
Price Discrimination Law
•
•
•
•
Illegal if it gives some firm an advantage
over other firms.
If individuals are consumers, is not illegal.
Price Discrimination is not likely to harm
efficiency. Perfect Price discrimination is
perfectly efficient.
Intention of this rule was to protect ‘momand-pop’ stores and grocers from
department stores and supermarkets. It
was intended to reduce competition.
Examples of Price Discrimination
•
•
•
•
Airline Tickets (Business and Vacationers)
Movies (adults, children, seniors)
Stamps, Coupons
Predictable Sales
Versioning
• Providing different models of product with
differing capabilities.
• Can be used to achieve price discrimination,
but also might just better meet consumer
demands.
• Artificial creation of
• Problem: avoiding cannibalization of higher
end product line.
Versioning Examples
• ‘lite’ versions of software with reduced
functionality.
• Putting identical chips in high and low
powered calculators.
• PC Junior
Lecture 3
Bundling (Block Booking)
•
Two or more products that are sold as a
package.
–
–
Related to ‘Tie-Ins’ but differs in that
bundling is not ‘contractual’. That is, when
you buy the bundle your purchase is finished.
A tie-in is a contract where you agree to buy
any of product X that you use, from a
particular vendor. But you need not buy X at
all. Example: if you buy a photocopy machine
from me, you also need to purchase any toner
that you need from me as well.
When Bundling Works Best
Successful Bundling Makes Demand More
Homogeneous
Px
Py
Qx
Qy
Px+y
Qx+y
Advantage of a Bundle
The Matrix Green Tomatoes Bundle
X
2000
1200
3200
Y
1300
1900
3200
2 x 1300
2 x 1200
5000
6400
Mod 2
• Information Goods
Public Goods
1.
2.
3.
4.
5.
Definition: Goods that do not get used up when
consumed. In other words, one person’s
consumption of a good doesn’t reduce anyone
else’s potential consumption of the same good.
Examples: Ideas, television broadcasts, national
defense.
Obviously, these are not physical items that get
used up. Instead they are usually ideas and artistic
expressions.
They are at the core of the Information Age
Economy, since information is a public good.
The Demand for Public Goods is the vertical sum
of individual demands.
Public Goods (cont.)
1.
2.
3.
Some definitions of Public Goods claim that
consumers can not be excluded from using
them. Known as Non-excludability.
Some Public Goods, such as broadcasting, or
national defense, appear to have this
characteristic.
This misses the point. Any product for which
consumers can not be excluded from using,
e.g., apples, will give producers no incentive
to produce.
Vertical Addition of Demands
P4
ΣD
P3
P2
D3
D2
D1
P1
Q1
Q
Public Goods
1.
2.
Book titles can be thought of as public
goods, but the physical copies of a single
book title are private goods that embody a
public good.
Several questions arise: how many titles
are optimal to publish? How many copies
of each title would be optimal? How do
competitive markets work? Monopolies?
Finally, is it possible to produce public
goods efficiently?
In principle, a perfectly discriminating
monopolist can produce efficient amount of
public good.
S
P4
P3
ΣD
P2
P1
Q
Q1
Q2
Lecture 4
The Market for a Title
1. Reproductions of a single Title are Private Goods
2. Seller of the Reproductions can not appropriate the
entire potential value of the reproductions since he is
not a perfect price discriminator.
3. With a single price for the reproductions, too few
reproductions are produced (Q*-Qm). One
component of lack or appropriation (area 7 in figure).
4. Consumers of the reproductions get surplus, which is
another loss of appropriation for the reproduction
seller. (1+2 in figure)
Production of a Single book title
Pm
1
2
4
3
7
MC of printing
5
6
Qm
8
D
Q*
MR number of copies of a title
Market for Titles
1.
2.
3.
Because appropriability for reproductions
of any title is imperfect, the sellers of titles
can not achieve the vertical sum of
demands (perfect discrimination demand
in next figure).
Instead, the best the sellers can do is some
distance below the vertical sum of
individual demands (attainable demand
curve in the next figure).
This leads to too few titles being produced
relative to the ‘ideal’.
•
Market Demand for Titles
Pm
Qm
Q**
Q*
number of titles written
Copyright Tradeoffs
• This leads to two tradeoffs:
– Under-consumption of individual titles.
– Underproduction of titles.
• This same tradeoff exists in Copyright.
• Copyright exists to give creators of ‘artistic’ works
the ability to generate revenues.
• The theory is that without copyright, competition
in selling reproductions of a title would drive the
price down to the marginal cost of producing a
reproduction. Competition would also drive the
(economic) profits down to zero, leaving no
money with which publishers can pay the author.
Copyright Tradeoffs
• It isn’t clear, however, that competition
leaves no payment for the author.
• Arnold Plant argued that being first gave
enough of a head start that sufficient profits
could be earned to allow authors to receive
optimal remuneration. (Ex. English authors
in the US market).
• The lead from being first is, with current
technology, unlikely to allow much profit.
Optimal Copyright
• The figure on the next page illustrates
optimal duration of copyright.
• It contrasts the gains from lengthier
copyright (the value of additional works
created) against the harms (unnecessary loss
of consumer surplus)
Patent (copyright) tradeoff
•
•
•
•
With no protection, creators do not reap
much of the rewards of their creations.
They are given monopoly protection,
which increases their revenues, but raises
price to consumers.
This increases the number of inventions,
but decreases the use of each invention?
We do not know the optimal tradeoff.
Lecture 5
Fair Use
• There is in the law an attempt to balance the
interests of copyright holders and those of
users.
• Fair use is a defense to copyright
infringement. It allows copying in instances
when the copying appears not to be hurting
the copyright owners revenues.
• Betamax Case said home videotaping was
fair use, and thus home videotaping was
allowed.
Fair Use
• 4 factors
– Amount of the copyright product that is copied.
– Nature of the Copyright product (commercial
versus academic or scholarly.
– Nature of the use of the copied product
– Impact on the revenues of the copyright holder.
• Last factor is the most important.
Indirect Appropriability
• Basic Idea: Producer Can Generate
Revenues from those making unauthorized
copies.
• Consumers who make duplicates are willing
to pay more for originals since the get value
from making duplicates.
• Producer can charge more for originals, thus
indirectly appropriating some of the value
in the copies.
Diagram of Copying Impact
P
D
V
DH
Q
Copying Outlawed
P
DH
Q
Diagram of Copying Impact
Impact of Piracy
• Although we don’t know whether copyright
currently has a duration that is too large or
too small, we still have to deal with piracy.
• Example of having all purchasers of CDs
make a cassette for their automobile is an
example where copying causes no harm,
and may even be beneficial, depending on
whether these individuals would have
purchased a second CD or prerecorded
cassette.
Evidence on Price Discrimination
and Indirect Appropriability
Dependent
variable
Constant Cites
Non-Profit Age
of R-square
Dummy
Journal
Plib/PInd
1.29
.0065 .65
[1.99] [4.14]
Plib/PInd
1.38
.0071 .578
[2.14] [3.36]
.17 n=80
-.16
[1.01]
.17
Continued
Libraries that:
1959
1983
Price Discriminate
3
59
Don’t Price Discriminate
35
21
Ratio of Book to Journal Expenditures, US Academic Libraries
1941
3.02
1961
3.19
1975
1.70
1944
3.41
1965
3.36
1977
1.54
1946
3.13
1968
3.67
1979
1.26
1950
3.01
1971
2.96
1981
1.13
1959
2.46
1973
1.96
Application to Napster
• Can indirect appropriability work in Napster-like
environment?
• Problem: large variability in the number of copies
made from each original
• Problem: identifying at time of sale which
originals are going to be duplicated.
• Large scale copying will harm copyright owners
significantly.
Newer Issues
• Automatic Rights Mechanisms
– Copyright owner can imbed code into software
that will monitor use and charge accordingly. It
can also prevent copying.
• Question: Is this protection ‘too strong’?
Fair use seems like it would disappear.
Copyright owner can now costlessly collect
revenues from users.
Lecture 6
Mod 3
• Network Goods
Network Effects
•
•
•
•
Increased market size makes product more
valuable to consumers.
This is just like an economy of scale in
that it benefits large firms relative to small
ones. Leads to natural monopoly.
It implies that demand increases for large
networks, and that prices should rise.
In Microsoft case, judge decided that they
are a barrier to entry.
Network Effects
• Definition: a product becomes more valuable to a
consumer the more other consumers there are of the
product.
• Virtually identical theoretically to economies of scale
• Markets will tend toward monopoly, winner-take-all
result (in simple world).
• Example: Fax machines, some software, languages,
online networks, computer standards,.
• Literal networks (physical connections, e.g., fax
machines) and Virtual Networks (e.g., software)
Characteristics of Information
Markets
•
Bigger is better, large firms (standards) have
advantages over smaller firms (standards).
–
–
Economies of Scale: large fixed costs
Network Effects
•
–
–
Definition: a product becomes more valuable to a consumer
the more other consumers there are of the product.
Instant scalability: the ability to increase output
extremely quickly. Not the same as zero marginal cost.
If these effects are not exhaustible, we have ‘natural
monopoly’, which used to be thought to require
government regulation.
Potential Problems Due to
Network Effects
• Traditional Problem: Network is the wrong
size. Old fashioned negative externality.
• New Problem: Getting stuck with the wrong
network—i.e., lock-in.
Effects versus Externalities
• Where we have positive externalities,
activity is too small (golf courses,
research?).
• Where we have negative externalities,
activity is too big (e.g., air pollution,
traffic).
• One key element is whether external effects
are internalized, or whether they are truly
externalities.
Tragedy of the Commons
•
•
•
•
Example of Negative Externality.
Common Property Resource – lake, forest,
any productive resource that allows free
use.
The tragedy is that the resource is
overused.
Greater tragedy is that it is overused to the
point where its entire value might be
dissipated.
Fishermen on Lake
Fishermen Fish per Fisherman Total Catch Marginal Catch
1
10
10
2
9
18
8
3
8
24
6
4
7
28
4
5
6
30
2
6
5
30
0
7
4
28
-2
Illustrating Overuse
Fish per
Fishermen Fisherman
1
10
2
9
3
8
4
7
5
6
6
5
7
4
Total
Catch
10
18
24
28
30
30
28
Marginal Opportunity
Catch
Cost
6
8
12
6
18
4
24
2
30
0
36
-2
42
Net
Value
4
6
6
4
0
-6
-14
Lock-in
• Claim: Markets do not adopt best products
even when it is efficient to do so.
– QWERTY, VHS-Beta are most common
purported examples.
• Story is one of coordination failure.
– We all prefer Beta. But VHS dominates, and
most movies are on VHS. Since we think that
everyone else will get VHS, we get VHS too.
• My work with Margolis has shown the key
examples of lock-in to be false.
Lock-in Table
T able 1: A D O P T IO N P A Y O F F S
N um ber of P revious A do ptions
0
10 20 30 40 50 60 70 80 90 100
T echnolo g y B (B eta)
T echnolo g y V (V H S )
10
4
11 12 13 14 15 16 17 18 19
7 10 13 16 19 22 25 28 31
20
34
• Technology B Wins although Technology A
is better.
40
Figure 1
V
30
B
20
10
Benefits
0
10
20
30
40
50
60
Number of Adopters
70
80
90
• Assumption about different slopes? What
does it really entail, and is it reasonable?
Qwerty Story
• Most famous case;
– simple to identify ‘quality’ (speed of typing)
– Consistent with chaos theories of unpredictable small events
leading to big outcomes.
• Usual Story:
– Qwerty Keyboard was designed to slow down typing to keep
keys from getting stuck.
– In a famous typing contest in Cincinnati, pitting touch typist
against ‘hunt-and-peck’ the touch typist used a Qwerty and won.
This is the small accident leading to big outcomes, since people
then associated Qwerty with speed.
– Prof Dvorak designed a keyboard to speed things up in 1930s.
– During WWII Navy tested new keyboard and found that speed
increased 40% and cost of retraining was recouped within 10
days of completed switch.
– Keyboard never adopted. End of war reduced Navy’s need for
fast typists.
Qwerty Story
• Actual Story
– No evidence that Qwerty Keyboard was designed to slow
down typing speed, and it wasn’t necessary to keep keys
from getting stuck.
– There were many other typing contest pitting touch typist
against other touch typists on different keyboards and
Qwerty won many of these. The point is that the
Cincinnati contest was not crucial.
– A highly publicized 1954 test of the Dvorak keyboard by
the General Services Administration found no advantage
in switching to Dvorak.
– The WWII Navy study was biased in the way it calculated
it results. All the biases were in favor of Dvorak. It also
appears that the author of the study was probably Dr.
Dvorak, the designer and patent holder of the keyboard.
– Ergonomics studies on keyboard design confirm that
Qwerty is a good design and not much different than
Dvorak in terms of speed
Beta-VHS Story
• Claim Story
–.
– Ergonomics studies on keyboard design confirm
that Qwerty is a good design and not much
different than Dvorak in terms of speed
Other Stories
•
•
•
•
•
•
•
Quadraphonic sound
Railroad gauges
Macintosh versus dos
Internal combustion engine
Metric versus English measurement
Stereo AM
AC versus DC
Network Effects
•
•
•
•
Increased market size makes product more
valuable to consumers.
This is just like an economy of scale in
that it benefits large firms relative to small
ones. Leads to natural monopoly.
It implies that demand increases for large
networks, and that prices should rise.
In Microsoft case, judge decided that they
are a barrier to entry.
Lecture 7
Business Applications
• Should a firm have internal charges when
one division helps another (e.g. technical
support)?
• Network Effects (again).
• Midterm, meeting 7
• Lecture 8
Measuring Network Effects
• Several attempts:
– Gandal examined spreadsheet prices.
• Examined whether Lotus file compatibility and
ability to link to external databases were
characteristics that led to higher prices.
– Brynjolfsson and Kemerer examined
spreadsheet prices
• Examined whether Lotus menu structure and
installed based lead to higher prices.
– Literal networks: fax machines (Saloner and
Shepard).
Network Effects and Software
• Standard Claims:
– Winner-takes-all.
• Market should gravitate toward a single winner.
• Note that ‘instant scalability’ can also lead to winner-take-all
type of result since market can follow preferences of
consumers more strongly than would be typical.
– Lock-In: Network effects presumably strengthen
monopoly of leader.
• Superior challengers can replace leader with built in network
effects until difference in quality becomes
– Tipping: At some point network effects support one
firm or product so strongly that it becomes the standard
and takes the market.
Quick answers :
– Product quality is key to success.
• Inferior products lose market share amazingly rapidly.
• Success seems to come only to the #1 product.
• Price plays only a small role.
– Evidence to support winner-take-all claims
– No evidence to support lock-in. In fact, quite the
opposite.
• Products deemed better seem to quickly replace inferior
products.
– No evidence of a ‘tipping’ point.
What has led to Software Success?
The same factor that causes success
in software markets in general….
Product Quality
•Measured by Magazine Reviews.
• We count ‘wins’ and measure
ratings.
Figure 8.7: Spreadsheet Wins
8
7
Excel
Quattro
Lotus
6
5
4
3
2
1
0
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
R atin g s
50
40
30
7
20
106
0
5
Lotus
E xc el
P C M a ga zin e
2/ 18/ 97
P C M a g a zin e
B yt e
12/1/ 96
2/ 1/ 98
PC W o rld
4/ 1/ 96
H om e O ff C om p
2/28/ 94
11/ 10/ 92
P C M a ga zine
12/ 31/ 91
P C M a ga zine
9/ 1/ 91
P C W o rld
6/1/ 91
Quattro
INF OW OR LD
By t e
7/ 1/ 89
Excel
2/ 8/94
8
10/ 12/ 92
60
IN FO W O RLD
70
P ers on a l C o mp u tin g
9/ 1/88
P e rs o na l Co m pu t ing
Figure
S Set R atings
Figure
8 .8 :8.12:
C o mRevenue
parison S hare
preadofshe
100
10
90
809
L otus
Q ua ttro
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
F igure 8.12: Revenue S hare of S S
100
90
80
70
60
E xc el
50
40
Q uattro
Lotus
30
20
10
0
1988
1989
1990 1991
1992 1993
1994
1995 1996
1997
9
8
7
Ami Pro
MS Word Windows
WordPerfect for Windows
PC Magazine
2/18/97
PC Magazine
11/21/95
PC Magazine
2/8/94
PC Magazine
11/9/93
PC Computing
8/1/93
PC Magazine
2/25/92
Infoworld
2/10/92
Infoworld
1/7/91
ComputerWorld
5/24/93
PC Magazine
12/11/90
Personal Computing
8/1/90
Figure 9.5: Windows WP Ratings
10
Word Processor Market Shares
100%
WordPerfect
Word Star
90%
Microsoft Word
Ami
80%
70%
60%
50%
40%
30%
20%
10%
0%
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Fig 9.21: M idrange DT P W ins
7
6
5
4
3
2
1
0
pre 1990
1990-1991
MS Publisher
1992-1993
Publish It!
94-95
96-98
Other
F ig 9.22: M id ran g e P C D T P S h ares
90%
80%
70%
60%
50%
Mic ros oft P ublis her
E xpres s P ublis her
S erif P ageP lus
O ther
40%
30%
F irs t P ublis her
C orel P rinthous e
P ublis h It
20%
10%
0%
1990
1991
1992
1993
1994
1995
1996
F ig 9 .1 0 : P e rs o n a l F in a n c e W in s
9
Managing Your Money
Q uic ken
Mic ros oft Money
8
7
6
5
4
3
2
1
0
86-90
91-92
93-94
95-96
97-98
Fig 9.12: M arke t S hare P C P e rsonal Finance
80%
70%
60%
50%
40%
30%
Q uic k en
M ic ros oft M oney
M anaging Y our M oney
20%
10%
0%
1989 1990 1991 1992 1993 1994 1995 1996
8.5
8
11 /1 /9 3
M a c U se r
6/ 1/ 89
10 /2 5/ 93
InfoW orl d
8/ 3/ 92
InfoW orl d
11 /5 /9 0
InfoW orl d
1/ 1/ 90
9
P e rsona l C om p ut in g
9.5
M a c U se r
6/ 20 /8 8
InfoW orl d
10.5
F ig . 9 .1 4 : HIg h E n d M a c in to s h D T P
10
P ageM akerM
Q uarkXP ressM
F ig u re 9.15: M arket S h are M ac H ig h -E n d D T P
80%
PageMaker
70%
Quark
Frame
60%
50%
40%
30%
20%
10%
0%
1990
1991
1992
1993
1994
1995
1996
5
4
3
6
1 0/10 /95
P C M aga zine
5 /6 /97
P C M aga zine
1 1/19 /96
7 /1 /95
C om puse rve
P C M aga zine
6 /1 1/9 6
8
M acu se r
AOL
P C M aga zine
6 /1 /95
M SN
P C W orld
2 /2 1/9 5
P C M aga zine
3 /1 5/9 4
P C M aga zine
2 /2 3/9 3
P C M aga zine
1 1/12 /91
P C M aga zine
F ig u re 4 1 : O n lin e S e rv ic e R a tin g s
11
P rodigy
10
9
7
Figure 9.27: Online Market Shares
AOL
CompuServe
MSN
Prodigy
70%
60%
50%
40%
30%
20%
10%
0%
1991
1992
1993
1994
1995
1996
1997
In 1994 Prodigy dropped its $14.95 unlimited use pricing and went to the
same pricing as its competitors ($10 for 5 hours, $3/hr after).
Mod 4
• Lecture 8
Mod 4 Lecture 8
• Products that lend themselves to the Internet.
• First, two types of Internet models
– Full Internet: no brick and mortar, only virtual. No
costs for warehouses, trucks, stores, salespeople,
and so forth. This was the original Amazon model.
– Partial Internet: Perhaps just for order taking (usual
warehouses, customers pick up from brick-andmortar retail outlet.
– Or some combination.
Characteristics of Products that are Likely to
Determine the Extent of the Internet Transformation.
•
•
•
•
•
Look to the mail order industry
Size and Bulk relative to Value
Immediate Gratification Factor (Impulse buying)
Perishability
Experience Products
• The Role of Taxes
• The Ability to Lower Costs
Types of Products Most Compatible with E-tailing?
• Digitized Products: no bulk, zero shipping
costs, immediate gratification.
– Computer software.
– Songs (when format issues, piracy, and
copyright issues are resolved).
– Videos (with same caveat)
– Information (databases, telephone numbers, and
so forth)
– Books: when E-books become practical for
most or many readers.
Markets likely to resist the Internet assault.
• Grocery Items : high bulk relative to value,
distribution systems likely to be inefficient,
many products are experience goods,
perishability problems.
• Automobiles: experience goods
• Furniture: experience goods, costly
shipping.
• Prescription Drugs: immediate need (instant
gratification.
Majority of Markets
• Can use Internet for advertising,
information, maybe sales.
• Shoppers could then pick up orders at local
store – this only makes sense if the Internet
experience is faster or cheaper for
consumers as opposed to going through the
store.
• Distribution systems not impacted.
Lecture 9
• Likely financial performance of Internet
firms.
Meaning of Profit Margins
• In competitive industries, economic profits
are driven to zero for the industry (or at
least for potential entrants).
• This mean that the return on investment is
equal to the normal return in competitive
industries (in equilibrium). Less competitive
industries can earn above normal returns.
• Normal returns on investment do not imply
normal returns on sales!! The return on
sales depends on the value added.
The Concept of Value Added
• Usually: The larger the investment as a
percentage of the sales revenue the larger
the percentage of total value of the product
sold that is created by the seller.
• This is the reason that supermarkets have
such low returns on SALES (but not
necessarily low returns on investment!)
Implications for E-firms
• Internet firms, particularly full Internet firms, are
expected to have lower costs than brick-and-mortar
firms.
• Who do Internet firms compete with? Brick-and-mortar
firms or other Internet firms? This is an important
question.
• If other Internet firms, then returns on sales will be
lower for Internet firms than the brick-and-mortar
counterparts.
• If the competition is really between brick-and-mortar
and Internet firms, then profitability depends on who is
more efficient, and this will determine returns on sales.
Advertising on the Net
• Original model was subscription based – AOL ISP
model with specialized content.
• ESPN, Wall Street Journal, Slate, and a host of
others tried this.
• Then advertising was added in, as in TV.
• Only WSJ and a few others stayed with
subscriptions. Others found that when they
charged user, number of users dropped
dramatically, hurting ad revenue and dashing their
hopes for large market share (they believed that
network effects made first movers the winners.
Advertising on the Net
• Net firms thought they could be solely advertising
based.
• The TV model that they were thinking of was a
flawed model. It was due to unusual historical
factors, not economic forces.
• Pure advertising models almost never are used:
magazines, cable networks, newspapers, all use
both advertising and subscriptions.
• Based on these analogies, the model that will win
in the end almost certainly will be a mixture of
advertising and subscriptions.
Advertising on the Net
• Net advertising revenues seem unlikely to be large
enough to support many sites.
• Banner advertisements are not going to be very effective.
Too small, too easy to avoid.
• Compare to TV ads: TV ads interrupt, have sound and
music, can provide an aura about the product. Until Net
Ads can do the same, they will never be as effective.
• Net ads do have an advantage of being very easy to
monitor (click-throughs) and sites can be very
specialized.
• Dot-com fever made the advertising model seem feasible
for a while, although even dot-coms went to TV to get
market share.
Lecture 10
• What happened to cause the melt-down in Internet
stocks?
– Trying to sell products on the Internet that didn’t make sense.
– Belief that first to market and market share leaders get to take
away all the winnings (misapplying network effects stories).
• See “The great Net giveaway gimmick” as an example of the mentality.
– Installed base was used to determine stock valuations. As if
profit per user were assured.
– Too much investment lead to lower returns.
– Throwing out usual business rules: profits, business plans,
managers with experience.
– Cash rich net firms overspent on advertising and each other,
causing a bubble that was amazing while it happened.
Too Much Investment
• Impact of ‘too much’ investment.
– As an analogy, even in the greatest oil find
imaginable, if firms have to bid on the fields,
and if there are many excited bidders, prices
can be bid so high that there are no profits after
the oil is developed. Look to the sale of
spectrum frequencies for an example.
– Additional investment depresses the prices that
can be charged the results of the investments
Lecture 11
• Interactive Pricing (Auctions) versus Listed
Prices
– Who benefits? Is it better for sellers? Buyers?
Could it be better for both?
– Is this a form of Price Discrimination?
– Are we going to move to a world of auctions?
History of Haggling
• Was common until recent times in Modern
Countries
• Why did it end? High cost of time
• Shopping with fixed prices is more
convenient than haggling.
• Will the Internet allow haggling without the
inconvenience?
Mod 5
• Public Policy and high technology.
Information Goods and Antitrust
• Winner-takes-all nature of these goods implies very
large market shares. It is efficient to have a standard.
• Competition may take a different form: competition
to be the next generation standard.
• Is there a role for these theories in antitrust? Are
consumers in danger?
• Owners of Standards need to coordinate consumers
and partners to achieve the best result. Could this
coordination appear ‘anti-competitive’?
Microsoft Case Background
• Microsoft ‘sells’ DOS to IBM for use on PCs. IBM
allows Microsoft to sell MSDOS to third party computer
manufacturers.
• PCs quickly eclipse Apple as leading computer
platform.
• Microsoft and IBM ‘jointly’ begin work on graphical
interface (OS/2) which has very ambitious specifications
and is not based on DOS. IBM’s attempt to recapture PC
market by having special version that only runs on its
PCs.
• Microsoft develops Windows as a temporary graphical
interface that runs on top of DOS. Tells IBM that it
doesn’t compete with OS/2.
Microsoft Case Background (cont)
• Windows 1.0 and 2.0 are flops, but Windows 3.0 takes
off in 1990.
• PC manufacturers quickly adopt Windows on the
machines they sell. Windows is much cheaper than
OS/2.
• Microsoft and IBM have a falling out and IBM takes
over OS/2 development.
• Microsoft develops Windows NT as a more advanced
OS to compete with high end workstations such as Sun.
Since Microsoft now dominates PCs, workstations are a
new market opportunity.
Microsoft Case Background (cont)
• 4 anonymous firms hire law firm (Gary Reback) to
lobby for government examination of Microsoft’s
tactics.
• Government investigates large market share of DOS.
FTC tie vote, and then Justice Department investigation.
• Government and Microsoft reach consent agreement
over Microsoft’s pricing tactics.
• Justice begins new investigation about Microsoft’s
inclusion of MSN with each version of Windows. AOL
claims it can not compete and that Microsoft was trying
to leverage its ownership of Windows to dominate
online services. AOL’s continued growth, however,
destroy the credibility of the claim.
Microsoft Case Background (cont)
• Justice then investigates Microsoft’s inclusion of
Internet browser (Explorer) with each copy of Windows.
Claims it is a violation of consent decree.
• Judge Jackson hears this case and orders an injunction
forcing Microsoft to sell to computer manufacturers a
version of Windows without the browser.
• Microsoft slaps judge in face by selling a version of
Windows without the browser, but which also doesn’t
operate.
• On appeal, Judge Jackson’s injunction is overturned.
Then Justice bring forward, along with 19 states, a new
antitrust case based on the browser.
Microsoft Case
• Government’s theory:
– Microsoft has a monopoly in its Windows OS. To strengthen
claim they argue that the proper market definition is Intel
based PCs.
– This monopoly is protected by network effects, referred to as
the “application barrier to entry”.
– Netscape browser, along with Java language, are a threat to
Windows since they allow programmers to write programs
that will run on any OS, removing the great appeal of
Windows, its large installed base.
– Microsoft engaged in illegal acts to protect its monopoly. It
foreclosed the market for Netscape's browser by tying Internet
Explorer to the OS.
Microsoft Case
• Problems with Government’s theory:
– Government’s view of network effects suffers from the fact
that there is no empirical support for the lock-in claim.
Software market examination earlier showed this (Microsoft
presented similar evidence after seeing galleys of the book).
– It isn’t clear that Netscape/java is a substitute for Windows,
and if it were it isn’t clear that its market share wasn’t big
enough.
– Showing consumer harm has become more important in
antitrust in recent decades, and government has had a hard
time demonstrating how consumers were hurt.
– The following charts illustrate Microsoft’s impacts on
consumers, at least with regard to price.
Impact on Consumers
F ig . 1 : W o rd P ro c e s s o r & S p re a d s h e e t P ric e s
$250
$200
$150
$100
Ave rage W o rd P ro c e s s o r P ric e
Ave rage Spre ads he e t pric e
$50
S ourc e: S . Liebow itz and S . Margolis , : W inners , Los ers and M ic ros oft:
C om petition and A ntitrus t in H igh T ec hnology , 1999, Independent Ins titute
$0
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Impact on Consumers
Figure 3: N orm alize d P rice C hange s
$140
$120
$100
$80
$60
$40
Non-Mic ros oft Markets
Markets W here Mic ros oft C om petes
$20
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Impact on Consumers
F ig u re 2 : Y e a rly P ric e C h a n g e s
30.00%
Non-Mic ros oft Markets
20.00%
Mic ros oft in Market
10.00%
0.00%
-10.00%
-20.00%
-30.00%
-40.00%
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
90%
$180
80%
$160
70%
$140
60%
$120
50%
$100
40%
$80
30%
$60
20%
$40
10%
$20
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
P C P ric e
M ac P ric e
P C S hare
Microsoft Word
M ac S hare
M ar k et S h a re s
W ho les ale P ric es
F ig u re 9.9: M icro so ft W o rd in M a c a n d W in d o w s
$200
$250
100%
$230
90%
$210
80%
$190
70%
$170
60%
$150
50%
$130
40%
$110
30%
$90
20%
$70
10%
$50
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
PC Price
Mac Price
PC Share
Microsoft Excel
Mac Share
Market Share
Wholesale Prices
Fig 8.15: Excel in PC and Mac Markets
Impact on Consumers
• What did government say about consumer harm?
– Three claimed instances:
• Wasted space on hard drive for Internet explorer for those people
wishing to use Netscape.
• Wasted time putting Netscape on computer instead of having OEM do
it.
• Lost innovation from Microsoft smothering everyone else.
– This last claim is obviously the most important, but it is
impossible to either prove or disprove. In general there is no
evidence that monopolists are less inventive than others. And
the fact that Microsoft has 120,000 developers indicates that
they do not destroy all the good ideas.
Lecture 12
• Microsoft Case
Lecture 13
Foreclosing Netscape
• Government claimed that Microsoft prevented Netscape
from being able to get its product into consumer’s
hands.
– Contracts with OEMs (computer manufacturers).
• Microsoft enforced a provision in Windows requiring that OEMs not
remove any Windows icons. They could add other Icons, such as
Netscape, but they couldn’t be larger than the Windows icons.
– Contracts with ISPs (Internet service providers such as AOL).
• Microsoft entered into agreements whereby the ISPs provided Internet
Explorer bundled with their service. Of course, users were free to use
any browser they wished. Microsoft tended to give their product away.
Foreclosing Netscape (Cont)
– Contracts with ISVs (independent software vendors such as
Quicken).
• These companies used Internet Explorer within their programs, say, if
users wished to access the web while using Quicken.
• Microsoft replied that:
– Netscape also had contracts with ISPs and OEMs. The one
with Compaq started much of the ruckus regarding the
placement of icons. Microsoft’s browser was ‘componentized’,
meaning that others could put their names on it, or use just
parts of it, Netscape’s wasn’t.
– Netscape's browser was available online and through carpet
bombing, with 100 million copies in the hands of users.
Foreclosing Netscape (Cont)
• Why did Internet Explorer gain market share?
– Government says for the reasons given above.
– Microsoft says that it gained market share because it
was a better product.
• Here is some evidence.
Fig 9.23: Browser W ins
8
Int Explorer
Netsc ape
Other
7
6
5
4
3
2
1
0
95-1
95-2
96-1
96-2
97-1
97-2
Fig 9.24: Browser Shares
100%
90%
80%
70%
60%
Netsc ape
Internet Explorer
50%
40%
30%
20%
10%
0%
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Giving Away Internet Explorer
• Judge believes there is no rational economic reason to
give Internet Explorer away, or to work so hard to get
ISPs and ISVs to use it, except to destroy Netscape.
• Of course, RealNetworks gives away its player os it can
make money on the server software. And CBS, NBC,
and so forth give away their programming, so they can
make money on the advertising. Etrade pays new users
to open an account. Juno gives away Internet service to
users who will watch the advertisements. So giving
away a product can have rational economic purposes.
Judge’s Findings
• Microsoft is a monopoly
• Accepted government’s case almost in its entirety.
• Didn’t hold hearings on remedy. Asked both sides
to put forward a remedy and accepted that from
the government.
• Decision was in two parts: findings of facts and
findings of law.
• Judge gave interviews during the case that
indicated that he felt Microsoft witnesses were
lying to him and were unrepentant. These
interviews didn’t come out until after his decision.
Government ‘Remedy’
• Structural and Conduct
• Structural (10 years)
– Two companies, one selling applications, the
other selling operating systems.
– They can not trade with one another.
– The application company gets all software
except operating systems [Windows, Windows
NT (2000), Windows CE]. Everything else goes
to the application company.
Conduct Remedies (3 years)
•
•
•
•
•
Uniform Windows pricing
Disclosure of APIs
No sabotage of competitors products
No exclusive dealing/tying
OEM Choice of Features
– Price of Windows lowered by size of features that are
removed.
• No agreements to restrict competition
• Continued sale of old versions without raising the
price.
Problems Created by Remedies
• The restriction on interaction, in combination with the
application company getting almost all products, will
make innovations in the operating system much more
difficult.
• Server software, voice recognition, developer tools all
belong with the operating system company. Operating
system is much weaker without them. NT was not part of
case, yet it is much less able to compete without server
software.
• For example, we get inefficient result if best voice
recognition was made by Microsoft.
• X-box problems: Hardware goes with application
company, operating system with OS company. 3DO tried
this and it failed.
Problems Created by Remedies
• X-box problems:
– Hardware goes with application company, operating system with
OS company.
– 3DO tried this model and it failed. It fails because game
hardware is sold often at a loss with the profits made up on the
games. That cannot be done if the OS and hardware companies
are different. Since Microsoft was the underdog in this market, it
can not be good for consumers to reduce competition here.
• Reduced competition in workstation/server market.
– Windows NT and 2000, with various server software packages
were supposed to compete with the likes of Sun and Oracle. It
will be much harder under the remedy to compete successfully.
Since Microsoft was the underdog in this market, it can not be
good for consumers to reduce competition here.
More Problems
• OEM choice of features.
– Seems innocuous, pay for only what you use, as on an a
la carte restaurant menu.
– Prices on this menu are a function of the number of
letters in the name of the dish???
– But an operating system is not a restaurant.
– The operating system is a type of standard, and this
choice fragments the standard. Software developers
can’t count on what features will be included.
– Example of Game Developer with sound compression.
More problems (cont)
• Even non-sabotage clause is unreasonable
– Microsoft shall not take any action that it knows will interfere with or
degrade the performance of any non-Microsoft Middleware when
interoperating with any Windows Operating System Product without
notifying the supplier of such non-Microsoft Middleware in writing that
Microsoft intends to take such action, Microsoft's reasons for taking the
action, and any ways known to Microsoft for the supplier to avoid or
reduce interference with, or the degrading of, the performance of the
supplier’s Middleware.”
• How do you define ‘performance’?
– Speed? Reliability? Quality?
– If Windows 98 moves to NT Kernal, performance improves
for machines with lots of memory, but decreases for machines
with little memory.
– How much testing does it need to do, on how many machines?
How many developers does Microsoft need to contact?
More problems (cont)
• Even disclosure of APIs, which I believe is a
worthwhile goal, is poorly done in the government
proposal.
– “To facilitate compliance, and monitoring of
compliance, with the foregoing, Microsoft shall create a
secure facility where qualified representatives of
OEMs, ISVs, and IHVs shall be permitted to study,
interrogate and interact with relevant and necessary
portions of the source code and any related
documentation of Microsoft Platform Software for the
sole purpose of enabling their products to interoperate
effectively with Microsoft Platform Software.”
– Doesn’t protect intellectual property.
– Inefficient way of disclosing APIs
Potential Costs
T a b le 3 : A d d itio na l C o s ts to C o ns um e rs f ro m hig he r A p p C o A p p lic a tio n P ric e s (B illio ns )
In US in 2 0 0 0
In US 2 0 0 0 -2 0 0 2
W o rld w id e in
W o rld w id e 2 0 0 0 -
assuming 2 5 % yearly
2000
2 0 0 2 assuming 2 5 %
gro w th.
1.
A p p licatio n
gro w th.
R ev enues p lus
$ 7 .5 5
$ 2 8 .7 7
$ 1 7 .8 6
$ 6 8 .0 9
2 . E xtra C o st A ssuming P rices
$ 1 .8 9
$ 7 .1 9
$ 4 .4 6
$ 1 7 .0 2
$ 3 .7 7
$ 1 4 .3 8
$ 8 .9 3
$ 3 4 .0 4
$ 5 .6 6
$ 2 1 .5 7
$ 1 3 .3 9
$ 5 1 .0 7
$ 1 1 .3 2
$ 4 3 .1 5
$ 2 6 .7 9
$ 1 0 2 .1 3
5 0 % M arkup
rise b y 2 5 %
3 . E x tra C o st A ssuming P rice s
rise by 5 0 %
4 . E xtra C o st A ssuming P rices
rise b y 7 5 %
5 . E xtra C o st A ssuming P rices
rise b y 1 5 0 %
D ata c om e from ID C S oftw are R eview and F orec as t, 1999. Mic ros oft applic ation s oftw are values c om es from page 147 table 1.
Mic ros oft developm ent tools c om es from page 114, table 8. 1998 values are inc reas ed by 25% per year, the expec ted grow th rate
ac c ording to tables 17 and 18, row for 32 bit W indow s m arket, w here app developm ent tools is expec ted to grow 25.6% annually and
applic ation s oftw are to grow 28.8% .
Potential Costs
T a ble 2 : A dditio na l C o s ts to C o ns ume rs fro m H ighe r W indo ws P ric e (B illio ns )
In US in 1999
In US 2000-2002
W orldw ide in
W orldw ide 2000-
assuming 15%
1999
2002 assuming 15%
grow th rate.
grow th rate.
N umber of PC s sold (in
45.10
180.09
113.32
452.53
millions)
E xtra
C ost
$2.18
$8.71
$5.48
$21.88
A ssuming
$9.54
$38.10
$23.97
$95.73
W indow s R ise s by $250
E xtra
C ost
A ssuming
$16.11
$64.32
$40.47
$161.62
W indow s R ises by $500
E xtra
C ost
A ssuming
$22.55
$90.04
$56.66
$226.27
A ssuming
W indow s R ises by $50
E xtra
C ost
W indow s R ises by $1000
D ata o n P C sale s c o m e fro m the ID C P C Trac ke r database . ID C e stim ate s ye arly gro wth in 3 2 -bit W indo ws o pe rating syste m s
and subsyste m s re ve nue s o f 1 8 .9 % fro m 1 9 9 8 -2 0 0 3 . Se e Table 6 , page 1 5 , Syste m So ftware and U tilitie s: 1 9 9 9 W o rldwide
M arke ts and Tre nds, Analysts: R . P aul M aso n, D an K usne tzky, and P hilip M e ndo za, ID C 1 9 9 9 . ID C also e stim ate s num be r o f
P C s shippe d to inc re ase by 1 7 % a ye ar fro m 1 9 9 9 to 2 0 0 1 .
An Aside: How Important are
OEMs anyway?
Figure 8.3: OEM Sales as Share of Sales of Office Suites
1996 units
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1996 Revenue
1997 units
1997 Revenue
Microsoft
IBM/Lotus
Corel
Market
Source: IDC
Tie-In sales.
•
•
•
•
Generally considered to be an ‘extension of
monopoly’ by courts. In other words, courts
believed it was an attempt to use one monopoly
to create a second.
Tie-In sales are poorly understood by courts,
imperfectly understood by most economists.
Frequently, tying good is sold very cheaply,
while tied good is very expensive. Famous
cases: IBM and computer cards, Xerox and
toner, Canning machines and tin plate.
Two monopolies are not better than one if
products are used together (in fixed proportions).
Tie In Sale when products used
together
PP
MC=AC pairs of shoes
2PL
PP-PL
MC=AC left or right shoes
PL
MR
Q1
D pairs of shoes
Q
PD version of Tie-In Story
1. Seller is thought to have two types of customers
– heavy versus light users.
2. Tied good is thought to ‘meter’ the use of the
tying good, to separate heavy from light users.
3. By lowering price of tying good, and raising
price of tied-good, producer increases payments
made by heavy user relative to light user.
4. Problems: heavy users likely to use up machines
faster – tie-in may have no impact on relative
payments.
Risk Reduction version of Tie-In
1. Consumers are unsure how much use they will
get from the tying good (machine).
2. This riskiness causes them not to be willing to
pay the full expected (predicted) value of the
product.
3. Seller has many such customers and can provide
‘insurance’ since the large numbers makes
overall results predictable.
4. By lowering price of tying good, and raising
price of tied-good, producer provides insurance
for consumers afraid they might not have much
use for machine.
Compatibility Costs of Fragmented Windows.
Descargar

No Slide Title