Transcript information lecture

Information and Pricing
Supply and Demand in Two Minutes
• Producers have a limited set of items to sell
– Each item has a marginal cost
• This is the cost of manufacturing, plus salary, R&D, etc.
• Consumers have a demand for items
– Amount they’re willing to pay
• Prices serve to moderate demand
– High prices reduce demand; low prices increase demand
• Prices also control production
– If price is less than marginal cost, firms enter
Supply and Demand in Two Minutes
• This all leads to the efficient market hypothesis
• Once supply and demand have equalized
– Profits are maximized
– Social welfare is maximized
• In some sense, this produces an “optimal” solution.
• There may be other criteria not met
– Fairness, moral issues, universal access
• This theorem is the primary argument for laissezfaire capitalism
– Let the markets work, things will equilibrate on their own
– The role of the government is to correct market failures
But …
• The “invisible hand” requires a number of
assumptions
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Low barriers to entry
Informed consumers
Scarcity
Excludability
Etc …
• What happens when these assumptions are
violated?
Information goods
• One unique feature of (digital) electronic
commerce is the ability to buy and sell
information goods.
• No physical good purchased; only bits are
transferred.
• Changes many of the rules of the game.
• Avoids direct competition with brick-andmortar vendors
Examples of Information Goods
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News articles
Mp3s, movies
Stock quotes
Software
Journal articles
Weather reports
More …
Features of Information Goods
• Information goods have a relatively high
fixed cost
– This is the cost to make the first copy of a
good.
• $300 million for Lord of the Rings
– Can be amortized over the number of goods
sold.
• Can discourage new entrants
Features of Information Goods
• Information goods have little or zero marginal
cost.
– This is the cost of making additional copies.
• Low marginal cost implies lots of consumers
wanted.
– Absorb high fixed costs.
• This is called increasing returns to scale
– As you sell more items, your profit per item increases.
• Advantages to being a large producer.
Low Marginal Cost
• Classical theory predicts that items in a
competitive market will be sold at marginal cost.
– Competitors will undercut until margin is reached.
• If marginal cost is zero, information goods will be
sold for no cost!
– No incentive to sell then.
– Obviously not the way things actually work.
• In the “real world”, information is not usually sold
in a competitive market.
– Copyright allows producers to hold a monopoly.
– Cartel structures inflate prices (e.g. music industry)
Features of Information Goods
• Information goods are nonrival
– This means that the amount one person consumes does
not affect the amount available to other people.
• This has issues for sellers of information goods
– Traditional price competition is based on scarcity
– If there are a limited number of widgets, people who
want widgets more will pay more for them.
• Luxury cars, houses, stock
– If there is no limit to the number of widgets available,
no one will want to pay more than the lowest price.
Nonrivalry
• Nonrivalry leads us back to the problem of
selling at zero cost
– If goods aren’t scarce, no one will pay for them
– If no one will pay for them, how do you get
people to manufacture them?
• “Traditional” solution: allow the
government to create a “natural monopoly”
– Prices are regulated so as to meet social goals
– E.g. telephone service before the AT&T
breakup, NSF/DARPA control of Internet
Nonrivalry
• Today, natural monopolies are seen as
counterproductive
– Corporations exert undue influence in pricing and
policy
• Content providers are still able to maintain partial
monopolies through copyright
– This allows them to set prices above marginal cost.
– Appealing to producers, but inefficient
– Some people would buy the good if it were available at
a competitive price.
Features of Information Goods
• Information goods are often nonexcludable
– This means that you can’t prevent someone from
getting the good without paying.
– File-sharing is the most obvious example.
• Workarounds include indirect taxes
– Britain has a set tax on televisions
• This means that information is sometimes thought
of as a public good
– Universally available, funded indirectly
– Like streetlights, police, highways, PBS
– Relationship between producer and consumer based on
reciprocity rather than need
Excludability
• There are several strategies for dealing with
the problem of excluding non-purchasers:
– Couple information to a physical medium (such
as a book)
– Encryption and licensing
– Auditing and user tracking (e.g. ASCAP)
– Embrace copying and bundle with content that
benefits from wide distribution (e.g. ads)
• Network TV does this – problem: maximizing
revenue does not maximize consumer surplus
Features of Information Goods
• Information goods are experience goods
(transparency)
– This means that a consumer doesn’t know exactly how
much she values an information good until after it is
consumed.
– Example: I don’t know how much I’ll like the new Lord
of the Rings movie until I see it.
– Compare this to a traditional good, like a car.
• Problem: consumers have a hard time determining
how much they’re willing to pay.
• Recommendations, reviews, try-before-purchase,
reputation become important.
Open Source as a Solution
• Open Source solves the transparency problem
– Full product is available for evaluation
• Excludability is the main weakness
– Solutions: gift economy, pay for service, increase
in “status” in labor market
• Some incentive for vendors to add proprietary
solutions on top of open source projects
– E.g Microsoft’s Java.
Pricing and Packaging
• All of these issues open the door for new
ways to price, package, and distribute
information.
• Solutions that might not make sense in a
physical economy become possible when
items being sold are digital.
• However, old rules and laws may not apply
– New rules and laws are needed
Bundling
• Information goods can be easily bundled and
unbundled
– Different packages can be easily created.
• When marginal cost is very low, bundling is an
attractive strategy
– If any consumers will pay for a particular good,
producers may as well include it.
– Advertising or subsidized products can be bundled to
increase revenue.
– Example: Cable TV, Microsoft Office, BonziBuddy
Bundling
• Bundling is also a nice way to deal with
heterogeneous consumer preferences.
• Example: two items: i1 and i2, two consumers c1
and c2
• c1 values i1 at $5 and i2 at $3
• c2 values i2 at $5 and i1 at $3
• Assigning separate prices to each item, the best a
seller can do is charge $3 and make $12 total.
• If a seller can bundle the two items together, he
can charge $8 and make $16 total.
– (there are similar examples in which consumers do
better with bundling)
Value-added bundling
• Bundling can be used to add value to an existing
product.
• A seller filters, bundles and organizes existing
information goods.
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RedHat
AP news wire
Brokerages
Cable packages
• Helps consumers deal with the glut of information
• Takes advantage of complementarity (two things
are more valuable together than separately)
Price Schedules
• Bundling is just one of a number of price
schedules that are possible when marginal
cost is very low.
• This makes a number of new schemes
possible for the sale of information goods.
• Gives producers more flexibility to
distinguish themselves from each other.
– Specialists (searchers) often prefer single items
– Generalists (browsers) want larger quantities
Price Schedules
• Per-article pricing (linear pricing): Every
item costs $p.
– Example: mp3 sales, back-dated NYT articles
• Bundling: Consumers pay a fixed price $b
for access to all goods.
– Example: cable packages, Salon, Netflix (sort of)
• Two-part tariff (subscription + fee) – Consumers
pay an entry fee $f, plus a per-item price $p.
– Buying clubs, rebates (fee is negative), amusement
parks, shared computer resources
Price Schedules
• Mixed Bundling: Consumers are offered a
choice between a linear price and a bundle.
– Microsoft Office vs Word, Excel
• Block pricing (discount pricing):
Consumers pay a price $p1 for the first n
items, and $p2 for each additional item.
– Grain, electricity, bandwidth
Price Schedules
• Nonlinear pricing
– Consumer pays a different price for each item.
– Logical extension of block pricing.
– Power consumption, water usage
• Each of these schedules implements a form
of price discrimination.
Price Schedules
• More complex schedules are able to fit
consumer demand more exactly.
Price Discrimination
• Goal: Charge different prices to different
consumers.
– Extract more surplus (consumer $$)
– Make it possible for more consumers to buy.
• First-degree price discrimination: explicitly
charge different prices to different
consumers.
– Hard to do, potentially illegal
Price Discrimination
• Second-degree price discrimination
– Different prices are charged for different
quantities.
• Third-degree price discrimination
– Consumers are grouped into different classes,
which are charged different rates.
• Different versions of software
• Airlines
• Senior discounts
Issues with Schedule Complexity
• In theory, a more complex schedule is better for
the producer
– Allows him to match consumer demand more precisely.
• Problems
– Complex schedules are difficult and confsing for people
• Agents may help with this
– If producers must learn what prices to offer, a tradeoff
develops
• Extra profit from a more complex schedule vs the cost of
learning more parameters.
Fixed Price Schedules
Simpler schedules can be learned more easily,
but extract lower long-run profit
Summary
• Information goods have a number of
characteristics that differentiate them from
physical goods
– Nonrivalry, nontransparency, nonexcludability,
zero marginal cost
• Sellers of information goods need to
account for the fact that traditional market
rules may not apply.
Summary
• Information goods can be easily packaged
and bundled.
• More complex pricing schedules are also
available
– Trade off the ability to precisely meet consumer
demand against number of parameters needed.