Economics of Information 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.
• First module is a review of Useful Economic
Concepts that you may or may not have had in the
past (in MECO 6201, which you should have had).
• Understanding the later modules will depend on
Some Useful Economic Concepts
• Price Discrimination
• Public (Information) Goods
• Consumer and producer surplus
• 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
If Elasticity is >1 known as elastic (responsive
If Elasticity is =1 ; unit elastic
If Elasticity is <1; inelastic (less responsive
Infinite and zero elasticity
Illustrations of elasticity
D with zero elasticity
D with infinite elasticity
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
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
Example of VideoTape Sales Demonstrates
Importance of knowing elasticity.
Why is Windows so Cheap?
• Elasticity indicates that Windows is grossly
under-priced relative to short run monopoly
• Find it hard to believe? Check out the
analysis for yourself.
Im pact of a 1%
Required % decrease
Minum um decrease in com puter
increase in the in num ber of com puters purchases brought about by a 1%
price of W indows
sold to m ake the
price rise in com puters that would
on the price of a
increased W indows cause a W indows price increase to
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
Consumer and Producer Surplus
CS = 1
PS = 2
DWL = 3+4
Monopoly Vs. Competition
Monopoly versus competition
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
• Downward sloping AC curve.
• More efficient to have 1 large firm than
many small firms.
• Rate of return regulation is how we regulate
• Removes incentive to keep costs down.
Losses with efficient output
• Two or More Markets
• Bundling and Block Booking
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.
Perfect Price Discrimination.
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.
price before discrimination
Price Discrimination Rules
Raise price in market with lower elasticity
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
Examples of Price Discrimination
Airline Tickets (Business and Vacationers)
Movies (adults, children, seniors)
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
Intention of this rule was to protect ‘momand-pop’ stores and grocers from
department stores and supermarkets. It
was intended to reduce competition.
• Sometimes (frequently) creating different
grades of products might just better meet
• Versioning is artificially creating different
products (where the high end product would
meet all needs) to achieve price
• Problem: avoiding cannibalization of higher
end product line.
• Luxury versus regular automobile brands.
• PC Junior.
• ‘lite’ versions of software with reduced
• Putting identical chips in high and low
Bundling (Block Booking)
Two or more products that are sold as a
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
Advantage of a Bundle
The Matrix Green Tomatoes Bundle
2 x 1300
2 x 1200