Session 4 - Information Goods

Question 1

What are information goods?

Answer 1

• For information and entertainment: e.g., pictures, audio files, video files, news, computer software, newspapers
• Symbols, tokens, concepts: e.g., virtual rewards, tickets, reservations, financial instruments
• Processes and services: e.g., public services (e-government services), auctions, interactive services
• An information good is a good whose unit production cost (including the cost of distribution) is negligible compared to its development cost
• Once an information good has been developed, additional units may be produced & distributed at nearly zero cost, for example, by allowing it to be downloaded via the internet
• In contrast with industrial goods, the unit cost of product and distribution are often dominant

Question 2

Utility of information goods

Answer 2

Information goods are not consumed in a classical sense (like a Big Mac), the information and utility behind the information are consumed.
- Information goods can be very easily achieved and accumulated. In this way, accumulated information can be used to generate long-term assets and new information goods (e.g., archiving daily weather forecasts can help making long term forecasts)

• Utility of information usually varies much more between consumers than with classical industrial or consumer goods (e.g., haired drier vs. mp3s)
  —> can be strongly dependent on the time of consumption (e.g., archiving daily weather forecasts can help making long-term forecasts)
  —> often depends on how many other consumers are using the same good (direct network externalities), e.g., WhatsApp, Skype, or video games
  —> can depend on the number of a second group of agents on a market or platform, e.g., restaurants on a review platform (e.g., Yelp). Here, the utility of information for a consumer depends on the number of other consumers/ review writers and on the number of restaurants on the platform (indirect network externalities)
• negative externalities can also arise. For instance, when a large group of consumers use the same streaming service, server performance can decrease
• utility of content can increase with exclusivity (for instance, stock price information), but this is very difficult to maintain in information goods markets.

Question 3

Name the three physical properties of information goods

Answer 3

1. Indestructability
2. Transmutability
3. Reproducibility

Question 4

Explain the physical property indestructability

Answer 4

• while long-lived consumer durables (e.g., washing machines) will stop working one day, this cannot happen to information goods
• there is no “second hand” market for information goods
• Business model impact: frequent updating & licensing

Coase Conjecture: e.g., when a firm competes with its own sales in previous time-period. And loses market power by its own sales
- The sales of consumer durables in one period decreases the demand for this good in the next period. The demand decreases, the prices have to decrease as well.
- Problem: Consumers can anticipate a price decrease and defer their purchase to later to wait for price decreases. When consumers are under no pressure to purchase, the pressure on the producer grows. Ironically, under this situation monopolists can behave as if they were in markets for perfect competition.

How can producers remedy this?
1. Credible and fixed price announcements
2. Rental models
3. Steady updates of products

Question 5

Explain the physical property Transmutability

Answer 5

Transmutability = something that is transmutable and can be transformed from one thing into another
- Extremely customizable
- Easily modifiable
- Producers lose some control over the integrity of their products
- Business model impact: differentiation by customizing and updating, selling as a service not as a product

Question 6

Explain the physical property Reproducibility

Answer 6

First unit of an information good involves high costs, afterwards they are easily reproducible
—> high fixed costs; not recoverable/ sunk costs

• Every other unit can be reproduced for virtually zero cost and with virtually no capacity restraints
• Natural monopolies tend to merge in these situations due to:
  1. Decreasing average costs
  2. Barriers to entry due to high fixed costs
  3. “Winner takes it all” markets

Question 7

Describe the production costs of information goods

Answer 7

The production cost of information goods is determined by the fixed costs (F) and the marginal costs (c). The foxed costs represent the initial investment required to produce the first unit, while the marginal costs represent the cost of producing each additional unit.

large F: costly to produce
Small or zero c: cheap to reproduce

Question 8

Explain the supply side economies of scale for information goods

Answer 8

Include table chapter 4

Question 9

Explain the implications of scale effects on market structure of information goods

Answer 9

Scale effects make commodity goods and perfect competition unsustainable for information goods. This is because in a competitive market, prices will be driven to zero when marginal revenue (MR) equals marginal cost (MC), making it difficult to recoup high fixed costs. Alternative market structures such as dominant firm/ monopoly with entry barriers or highly differentiated products become more feasible/ more likely.

Question 10

What strategies can be used to achieve sustainability in the supply side of information goods?

Answer 10

—> Cost strategy
Reusability: selling the same good again to reduce production costs

Question 11

What strategies can be used to achieve sustainability in the demand side of information goods?

Answer 11

—> Revenue strategy
1. Differentiate your product: add value to raw information to distinguish yourself; target specific markets
2. Move to advertising model
3. Build a network/ community
4. The key is to learn from your customer

—> know your customer: ask for registration, observe queries, observe clickstream, behavioral targeting