The Economics of e-Commerce and the Internet



The Economics of e-Commerce and the Internet

Edward J. Deak, Ph.D.

Ch. 1 – Answers for Discussion and Review Questions

1. What does it mean to say that distance is dead? How have e-commerce and the Internet contributed to the death of distance?

Physical distance is a barrier to trade that raises the cost of a transaction and effectively limits the number of buyers and sellers that are in market proximity to one another. The physical barrier of distance has been lessened significantly by the introduction of e-commerce via the Internet. The Internet allows an average person, located anywhere on the globe, to contact others electronically at the speed of light. Therefore, buyers have a potentially wider range of sellers, outside of their physical location, to contact and transact with. Sellers too have a wider range of potential customers in the market. Therefore, a highly specialized business that was located in too small of a physical market to survive, may thrive in a global market of electronic customers.

2. What is empowerment? How have e-commerce and the Internet worked to empower the consumer?

Empowerment is the act of being awarded authority or power to act. The Internet and e-commerce give power to act to the consumer in terms of time, knowledge and efficiency of action. The Internet is open 24/7 allowing consumers to shop at their convenience. The range of the Internet allows the consumer to acquire more information about a potential transaction. Lastly, with the ability to contact more sellers should increase competition, lessen prices and improve the terms of trade for buyers.

3. Define the branch of economic inquiry known as the “economics of search.” How do the Internet and e-commerce alter the behavior and efficiency of the search process?

The economics of search looks at the consequences of time, information and distance as important impediments to market efficiency. The resource costs associated with overcoming some portion of these impediments leads to the calculation of an optimal level of search. This level appears at the point where the incremental gains from added search effort just equals the cost of directing added resources to the search effort. The Internet and e-commerce work to reduce the resource costs in terms of time and effort devoted to acquiring an additional unit of market information. Therefore, buyers and sellers can increase their knowledge surrounding a market transaction and reduce the degree of imperfect information.

4. What is the nature of the tension that exists between the value of conducting additional search and the cost of acquiring additional information? Is it irrational for a consumer to acquire all of the information that exists before entering into a transaction? Why?

The search effort involves an opportunity cost in both time and resources spent on the search. Therefore, acquiring additional information, which usually has a positive but declining incremental value, is often increasingly more difficult leading to incrementally rising costs in both time and resources expended. This tradeoff creates a tension that leads to determination of an optimal level of search effort. It is normally irrational for a consumer to acquire all of the information that exists regarding a market transaction, because at some point the added light may not be worth the expenditure of the additional candle.

5. Distinguish between the consequences of perfect versus imperfect information as each affects the efficiency of exchange. What kind of imperfect information is typically found in the marketplace for final goods and services?

Perfect information involves both parties having full knowledge of the economic conditions of a market transaction such as lowest price, best quality, most reliable service and the ensuing consequences of the exchange. Imperfect information about the parties to a transaction, as well as the price, quality or conditions of sale can lead to mistakes being made in the exchange process that lower efficiency. Final transactions typically involve some imperfect buyer information regarding lowest price, product quality or the reliability of the seller. Sellers have imperfect information regarding the buyer’s willingness to pay or behavior subsequent to undertaking the transaction, either of which might levy a burden on the seller.

6. Describe the tension that exists between competition through product differentiation and competition through price. Why would challenge using competition through price? Won’t this approach just lead to lower prices and profits for both firms? Why?

Competition through price involves attracting buyers by offering the lowest possible price for the product. Competition through product differentiation involves attracting buyers on the basis of unique product characteristics. Different firms can employ these alternative strategies and compete with each other in the same market. For example, McDonald’s Burger King and Pizza Hut compete with each other in the low end of the market for food away from home. chose to compete with e-tail industry leader using a low price strategy as a way to establish itself as a major player in the e-tail market. While some segment of buyers will be attracted to the low price seller, other buyer segments seek the convenience of Web site use, perceived reliability, friendly experience, and wider range of products offered at .

7. When does a differentiated product become a commodity? Is it advantageous to a firm to have its product regarded as a commodity by consumers? Why?

A commodity product is one where consumers perceive few if any real differences among the characteristics of the product offered by one seller versus the remainder of the market. Bananas are classic commodity products, but desktop computers have become a commodity in the eyes of many buyers. It is usually highly disadvantageous to a firm to have its product seen as a commodity by potential buyers. This is because the principle way to distinguish and sell your product is through the lowest possible price, which usually leads to diminished profits.

8. What are Internet backbone carriers? Why did so many of them experience financial problems. Are these kinds of problems unusual in the early stage of a new technology? Why?

Internet backbone carriers are the limited number of telecom firms such as UUNET/WorldCom, Sprint, Qwest and Genuity that carry the bulk of electronic Internet traffic among Internet Service Providers. For a list of backbone firms link to . Many of the financial problems that have been experience by the backbone firms are related to a combination of two factors. First, unreasonably high expectations for the rate of growth in Internet traffic and second, racing behavior where competitive firms s simultaneously invest in capacity to capture the same growth in market demand. Both of these conditions have created intermediate term excess capacity in the industry. These kinds of competitive capacity problems and business failures are not unusual in periods of rapid technological change as evidenced by the turmoil in the U.S. railroad industry in the 1800’s and the automobile industry in the early 1900’s. Entrepreneurial excitement and hype often get ahead of market reality.

9. Why did so many dot-coms die an early economic death? Does the demise of hundreds of dot-com e-tailers necessarily mean that the commercial value of e-commerce is a failure? Why?

Several reasons accounted for the failure of so many dot-com e-commerce firms including weak or non-existent business plans (failing to plan means planning to fail), weak management, inability to gain Internet visibility and attract customers, insufficient capitalization and sometimes old fashioned fraud. Despite the failure of many e-tail dot-coms, others have survived and are making money today. The future of e-tailing is bright and promising as long as the firm has the right combination of a viable business model and the array of assets to carry out the model efficiently.

10. Explain how the Internet is just the latest stop on the evolutionary road tracing changes in communications technology.

The Internet is evolutionary not revolutionary. It is just the latest phase in our advance of communications technology. At first, communication was spoken or written, but later progressed to printed, direct wire and later wireless systems. The Internet is electronic in nature but it is unlikely to be the last stop in the changing way that business and people link to one another.

11. Define the term electronic commerce (e-commerce) and identify the two distinguishing features of this definition.

E-commerce is the act of doing business over the Internet. The two distinguishing features of the e-commerce definition are its use of Internet technology as the means of contact, and the fact that doing business can include the provision of free to the viewer content that might otherwise be supported by some other form of payment such as advertising.

12. Define the term Internet and explain how it related to the concept of the World Wide Web.

The Internet embodies an electronic technology that joins together otherwise independent networks of computers. The World Wide Web is the most popular and common application on the Internet that uses this interconnection technology. The Web, through the use of a browser, allows for the display of words, pictures, graphics, sound and video along with a simple way of accessing information by linking one site on the Internet with another.

13. Distinguish between a virtual market and physical marketplace. Why must e-firms recognize that they are really competing in both of these markets?

A physical market is tangible and typically comprised of brick-and-mortar stores. A virtual market exists only in space and imagination without the benefit of a physical presence. The New York Stock exchange is a physical market, staffed by human traders meet face to face and located on Wall St in New York City. However, the Nasdaq is an electronic or virtual market, where banks of computers link the purchase and sales intensions among stock traders. Many e-tailers such as Wal-Mart and Target operate in both physical and electronic markets. However, even Internet only e-tailers such as must recognize that potential buyers always have the option of trading in the physical as opposed to the virtual marketplace. Therefore, they find themselves in competition with both virtual and physical rivals.

14. Define economics. What are some of the issues and questions raised by economics as it looks at the operation of e-commerce?

Economics is the social science that studies how relatively scarce resources are to be allocated efficiently among relatively unlimited human wants. Efficiency means getting a product at the lowest possible resource cost or using a fixed amount of resources to achieve the greatest volume of desired goods and services. Some of the questions and issues that economics raises as it looks at e-commerce behavior involve the structure of e-commerce markets including the number and relative size of firms, the method that e-commerce firms use for pricing and differentiating their products, and how e-commerce firms deal with risks, generate profits and react to change.

15. What is an economic tension? How helpful is it to frame the discussion of Internet and e-commerce issues in the form of a tension?

Economic tensions define points of competitive conflict or frictions that pull the market process in different directions. Forming the discussion of e-commerce frictions, tradeoffs and conflicts in terms of tensions works to highlight for the reader the choices and controversies that surround the electronic exchange process.

16. How many people have access to the Internet globally, and by region? Where do users go and what do they do when they are online?

As of May 2002, some 580.78 million persons or 9.5% of the global population had access to the Internet. Europe had the largest number of persons with Internet access at 185.82 million followed closely by North America at 182.67 million. E-mail is the most popular Internet activity, undertaken by 90% of users, while some 77% of Internet users employ the technology to search for general information.

17. How large is B2C and B2B e-commerce activity? Explain the disparity in the dollar volumes of the two activities.

B2C retail sales amounted to $35.9 billion in 2001, while B2B business sales totaled nearly $1 trillion in 2000. The ratio of B2B versus B2C sales was in excess of 21:1. Part of the discrepancy involves multiple transactions where e-commerce sales of the same product are recorded at different stages of the production process. Another cause of the relatively larger B2B sales number comes from the unrelenting competitive pressure to find cheaper and more efficient ways of doing business. Enhancing business efficiency has proved to be a hallmark of B2B transactions.

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