Essential Principles of Economics: A

Hypermedia Text
2005

Autor: Roger Ashton McCain III

Chapter 16

Economics of Information Products

Fuente: http://william-king.www.drexel.edu/top/prin/txt/infoch/InfoToC.html

What is Information?

As a first step, we need to get a clearer definition of the topic.

But what is this stuff, "information?" Before we can go very far, we need a definition of
information goods and services, and that is a pretty controversial subject in itself.

Here are some examples of the trade in information goods and services:

1. A newly invented machine is patented, and the patent is licensed to a company that
plans to build and sell the machine.
2. A new edition of a best-selling travel guide is published.
3. A public library buys 3 copies of the travel guide to lend (free) to its patrons.
4. A financial advisor offers his clients advice and opinions about profitable
investments in return for a commission on their investment transactions.
5. An investor consults a World-Wide Web page for the values of "leading economic
indicators" (key economic statistics) supplied by the U. S. Commerce Department.
There is no charge.
6. A collection of photographs of great paintings in world museums is put on CD-
ROM and sold by a computer software company.
7. A record company publishes a boxed set of CD's with a digital recording of a recent
performance of Mozart's "Marriage of Figaro," with Bryn Terfel singing the role of
Figaro. The set includes the libretto of the opera.

What these examples have in common is that information goods and services are being sold
(or given away). For the purposes of this chapter, information goods and services share
these properties:

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a) An information product is a collection of symbols.

b) Its utility depends on the arrangement of the symbols, not on the material form that they
take.

More Details on the Examples

Thus, for example, the plans for the newly invented machine are an information good. They
are symbolic (perhaps pictorial as much as verbal) and their usefulness is the same whether
they are on paper or some electronic form. Similarly, the utility of the travel guide is about
the same whether it is from the original print run, a Xerox copy, or scanned and mounted
on a computer disk. The utility of the travel guide may also be nearly as great when it is
borrowed, and has to be taken back in a month, as when it is bought -- after all, by that
time, the traveller is likely to have planned her trip and made her reservations. Yet again,
the utility of the financial advice will be similar whether it is obtained orally or printed on a
"market letter," -- assuming it is the same advice, that is, that the symbols are arranged in
the same way. The photographs of the museum pictures are coded in a symbolic form --
one of the electronic picture standards, such as JPEG, TIFF or GIF -- and the utility of the
coded photographs is pretty much the same whether they are on CD, downloaded from a
Web site, or broadcast on cable TV. Anyway, the coded photographs are worth much less
than the originals because the originals are physically the paintings the great master
painted. That is, the originals are not information goods because their utility comes from
the material form they have, as much as from any arrangement of symbols. Similarly, the
performance of "The Marriage of Figaro" was not itself an information product, since its
utility depended on the material circumstances, including the vibration of air molecules set
in motion by Terfel's extraordinary tenor voice. However, the score and libretto (script) of
the opera are information products. They can be performed again and again, and what gives
them value is the arrangement of symbols to guide the future performances (and to aid in
the enjoyment of the music by those who buy the CD set). Also, the CD's themselves are an
information product, since the music is coded and the particular arrangement of digital
codes is what produces music from the CD player, giving the CD's their value. Had the
same digital codes been encoded on digital audio tape, they would have given the same
utility (to those who have digital audio tape players, of course).

We may extend this definition of information products by observing that information

services are services that provide or involve the manipulation of information products.

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Economic Characteristics of Information
Products

This definition and these examples of information products point toward some of the
distinctive economic and organizational characteristics of information products:

• Media of Transmission
• Uniqueness
• High Fixed Costs
• The Incentive Problem
• Intellectual Property

Media of Transmission

Information products cannot be bought or sold alone. While it is the arrangement of

symbols that gives utility, the symbols have to be recorded or expressed in some material
form. In the examples above, we have symbols recorded on paper blueprints and plans, on
paper in a bound book, expressed in oral speech, in computer code on a hard disk, and on
compact disks. Each of these is a "medium" for the preservation and transmission of the
symbols, and the plural of "medium" is "media." Information products cannot be bought,
sold, given away or even preserved except in conjunction with some medium.

Uniqueness

In the ideal competitive markets discussed in economics textbooks, the goods traded are
assumed to be "homogenous." Since it is the specific arrangement of symbols in an
information product that gives utility, information products cannot be "homogenous." For
example, even if computer spreadsheets differ only a little in "look and feel," computer
spreadsheets are not a "homogenous product.1 " This means that there always is an element
of monopoly in markets for information products.

High Fixed Costs

1
If two spreadsheets hypothetically had exactly the same "look and feel," then they would be the same
information product. It is the arrangement of symbols on the screen -- not the arrangement of symbols in the
program code -- that gives the customer utility.

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Since the information product is not sold alone, but in conjunction with some medium, the
costs of the information product itself are largely independent of the number of copies sold
in the various appropriate media. That is, from the viewpoint of the seller, the costs of the
information product itself are fixed costs, and the only variable costs are those of the media.
Information producers have this cost structure in common with public utilities and "natural
monopolies" of all kinds, and as the phrase indicates, high fixed costs have some tendency
to give rise to monopoly (though the term "natural monopoly" is probably usually an
exaggeration). Of course, this reinforces the tendency toward monopoly created by
uniqueness.

Incentive Problem

Since it is the arrangement of the symbols that gives utility, it may be very easy and cheap
to duplicate the information product. For example, once an inventor has worked out plans
for a valuable invention, others can use the plans to produce the machine without sharing
the cost of developing the invention. In general, a valuable arrangement of symbols can be
imitated. That is, imitators can arrange symbols in the same way in the same or another
suitable medium. In general imitation is less costly than original work, and thus the
imitators can undersell the originator. In effect, the imitators need not bear any of the fixed
cost of the original information product, but only the variable cost of the media. Other
examples are those who "pirate" software and recordings by making unauthorized copies.
This may make it very difficult for originators of information products to recover the cost
of their work, let alone profit by it. If this is so, then there will be little incentive to
originate information products, and this would be inefficient. This is the "incentive
problem."

Intellectual Property

As a means of remedying the incentive problem, the law may give the originator of an
information product some exclusive right to control use, or sell the information product,
regardless of the media in which it is expressed. Rights of this kind are called rights of
"intellectual property." Patents for new inventions and copyright on new written or artistic
work are examples of intellectual property.

(Aquí nos saltamos varios capítulos)

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Information as a Quasi-Public Good

The difficulties in providing efficient incentives for the production of information products
through property rights lead some people to say that information is a public good. But this
is inexact.

The definition of a public good2 in economics is narrow. In economic theory, "a public
good" has two characteristics:

1) The cost of providing the good does not depend on the number of consumers who
benefit from it.

2) It is not feasible to exclude those who do not pay from the benefit of the good.

Economists have traditionally argued that, because of these characteristics, public goods
will not be supplied by a profit oriented market economy. If they are to be supplied at all,
government3 must supply them.

We may use Adam Smith's example of the lighthouse4 to illustrate this concept. The
lighthouse exists to warn passing ships of a dangerous shoal or coast. All ships that come
within sight of it benefit from it. The cost of maintaining the lighthouse is a fixed cost, and
does not depend on the number of ships that benefit from it. It would, at best, be difficult to
intercept ships as they come within range of the lighthouse and demand that they pay a toll
for using it -- but even if it were done, it would do no good. The ships would know their
position simply because they were asked to pay, and would correct their course to avoid the
danger -- getting the benefit without paying! So the lighthouse fulfills the definition of a
public good.

2
The use of the indefinite article here -- speaking of "a public good" and not of "the public good" -- makes a
big difference. "A public good" is a particular good or service that may or may not be efficiently supplied by
the government. "The public good" is the overall objective of good government. The noun "good" is
differently used in the two cases. In "a public good" it is concrete and specific, referring to particular services
or objects of use. In "the public good" it is abstract, roughly a synonym for "well-being." Thus in general we
might think that "the public good" would be advanced by having government supply "a public good," but
there could be exceptions and counterarguments.
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Or philanthropy might supply them. The correct conclusion is just that profit-oriented private action will not
supply a public good, and even that must be qualified if the group of beneficiaries is small enough to conspire.
Economists have traditionally not considered philanthropy, since it does not fit well with the "economic man"
conception; but for some information services, such as public libraries and schools, philanthropy has been an
important source of supply.
4
Coase argues that even the lighthouse does not meet criterion 2, and he supports the argument with historical
reports of ways in which lighthouses were supported in late medieval and early modern Britain. However, I
interpret his examples as examples of government provision, dating from a time and culture in which
government was differently understood and organized.

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Is it an information product? Yes. A light per se may not be considered a symbol, but in the
context of a map (which is symbolic) and a route plan, the light takes on a (symbolic)
meaning it would not have out of context. Moreover, some lighthouses flash in specific on-
and-off patterns, to make it easier to identify them. This is symbolic in the strictest sense,
and the light is the medium, not the information product.

Well, then: are information products, in general, public goods? The answer is no. They are
not public goods because an information good cannot be transfered without at the same
time transferring the medium. In the case of the lighthouse, the medium -- light -- is itself a
public good. But in other cases, such as books, the medium (paper) is not a public good.
And publishers are to some extent able to collect from those who benefit from the book. At
the very least the publishers can collect from the first purchaser of the book. Since the
information product can only be sold in conjunction with some medium, the information
product is a public good only if the medium is a public good.

Quasi-Public Goods

But there is an important middle ground between public goods and purely private goods.
We might define purely private goods by negating the two characteristics of public goods
given above: For purely private goods,

1a) The cost of providing the good increases at least proportionately to the number who
benefit from it.

2a) It is always feasible to exclude from the benefit of the good those who do not pay for it.

An example of a pure private good is a potato. If I eat the potato, you cannot, and it will
cost twice as much (or more) to double the production of potatos. Also, the farmer can
demand that I pay for the potato before I take it home -- so, unless I steal it, I can benefit
from it only if I pay. Pure private goods are at the other end of the spectrum from pure
public goods.

The intermediate category we may call "quasi-public goods," since they share the
characteristics of public goods to some extent. For quasi-public goods,

1b) The cost of providing the good increases less than proportionately to the number who
benefit from it.

2b) There are some difficulties in excluding those who do not pay from the benefit of the
good.

These two conditions are relative. Some quasi-public goods will come nearer the public end
of the spectrum, in that costs increase much less the proportionately than the number of

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beneficiaries and the difficulty of excluding non-payers is quite considerable. Other quasi-
public goods will come nearer the purely private end of the spectrum, in that costs increase
almost in proportion to the number of beneficiaries and the difficulty of excluding non-
payers is slight. The nearer the good is to the public end of the spectrum, the greater its
"degree of publicness" is. The greater its "degree of publicness" is, the greater the incentive
problem is.

It seems clear that information products typically are not public goods but are quasi-public
goods. Their degree of publicness varies widely, though, and changes in technology
(media) can change the degree of publicness. It seems likely that the trend of technology
has been to increase their degree of publicness. Nevertheless, most information products
continue to be supplied by profit-oriented private business. Thus, unlike pure public goods,
government provision will not be necessary in most cases, and may make things worse in
some cases.

Horse-Race Effects: A Contrary Tendency

We have considered several reasons why markets might not allocate "enough" resources to
the production of information products for efficiency. These tendencies to underallocation
are most pronounced if there is no intellectual property right, but may be present to some
extent even if there are intellectual property rights. However, some economists5 have
argued that there may also be tendencies to overallocate resources to the production of
some kinds of information products. These tendencies come into play whenever the first
person to achieve some result gets a special reward, as, for example, a patent for the first
successful design of a new invention. Thus, the economic activity becomes a "horse race"
in which only the first horse across the line can win -- and accordingly, we might speak of
them as "horse race" effects. Markets affected by these tendencies are often called "winner-
take-all" markets, and this sort of competition is called "winner-take-all competition.

To illustrate how this can happen, we look at a potential competitor's decision whether to
enter the market or not. A pure winner-take-all market would work like this: it is a market
for a good or service that can have greater or lesser quality -- a form of computer software,
perhaps, or CD's of performances of a Mozart opera, or an electronic game. The good is
produced with strong economies of scale -- the more the company produces, the cheaper
they can sell it and still make a profit. Thus, the market will be dominated by a single seller,

5
This discussion is largely motivated by a discussion by Jack Hirschliefer: Hirshliefer, Jack (1971), "The
Private and Social Value of Information and the Reward of Inventive Activity ," American Economic Review
v. 61, no. 4 (Sept.) pp. 561-574. Note also Loury, G C (1979), " Market Structure and Innovation ," Quarterly
Journal of Economics v. 93, pp. 395-410, Dasgupta, P. and J. E. Stiglitz (1980), " Industrial Structure and the
Nature of Innovative Activity ," Economic Journal v. 90, pp. 266-293, DasGupta, P (1988), "Patents, Priority
and Imitation: the Economics of Races and Waiting Games ," Economic Journal v. 98, no. 393 (Mar) pp. 66-
80. For a survey of issues related to intellectual property including the horse race conception, see Besen, S. M.
and Raskind, L. J. (1991), "An Introduction to the Law and Economics of Intellectual Property ," Journal of
Economic Perspectives v. 5, pp. 3-27.

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and the new competitor will be able to sell the product only if they can produce a product of
better quality than the one already in the market. On the other hand, if they can do that, they
can take over the market and drive the older firm out.

An industry with strong economies of scale is often called a "natural monopoly," since
there is a tendency for one firm to dominate the market. We will assume that, before the
new competitor enters, the market is dominated by a single firm. Suppose that the demand
for that one good is shown by line D1 in Figure 4 below. Suppose also that the marginal
cost is shown by the horizontal line V, so that P is the profit-maximizing price and Q units
of output are sold.

Figure 4
Another potential seller is considering entering the market to sell a better-quality substitute
product. If it is introduced, its improved quality will enhance consumers' utility in such a
way that 1) at the same price, 100% of the consumers will substitute the new product for
the old, and 2) the resultant demand (marginal willingness-to-pay) curve will be that
indicated by D2. The new company can enter if it will commit a development cost of Y.

Will entry be efficient? We will apply a cost-benefit test: are the benefits greater than the
costs? The introduction of the new product will increase consumers' surpluses by area
ABC, while industry profits will be increased by CBED. Thus, entry is efficient if the
benefits, additional profit plus consumers' surplus, is greater than the cost.

1. Y < ABC + CBED

However, the new entrant will replace the old entrant completely, and so will earn a profit
of pBEV. Thus, the potential entrant will decide to enter if

2. Y < pBEV

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In the diagram, it appears pretty clearly that ABC + CBED < pBEV. Suppose ABC +
CBED < Y

The extra profits from monopolizing the market mean that profit-maximizing business will
spend too much on product development and on competition to gain control of their
markets. Many new goods of higher quality will be produced, and that's a good thing in
itself, but only up to the point at which the benefits balance the costs. In "winner-take-all"
markets, producers take the development costs beyond that point, making too much of a
good thing a bad thing.

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Information Oversupply

Is it realistic to suppose that there could be inefficient overproduction of some kinds of

information products? New classical musical compositions are information products, and
one study indicates that they are being written in greater numbers than can be performed, so
that the backlog of unperformed compositions keeps increasing. 6 In markets for textbooks,
new editions are brought out at fairly frequent intervals, in order to "kill off the resale
market," that is, to make used copies obsolete so more new copies can be sold. Similarly, in
markets for software, new versions are frequent in part as a means of making the copies not
in people's hands obsolete. Investment to create obsolescence can also lead to tendencies to
overinvestment. Certainly, markets do allocate substantial resources to the production of
information goods in these industries.

In some of these cases, there may be non-profit-oriented motivations for supply of

information products. Some of the classical musical compositions may have been written
more because the composers enjoyed expressing themselves in this particular media. and
while textbooks usually seem to be published with a view to profit, some other books are
not. "Subsidy publishers" produce books paid for by the authors -- and their profit margin,
if any, comes from the fees paid by the authors. The profits from the publication, if any, go
to the authors. The books produced by subsidy publishers include political and theological
tracts that express the strongly held beliefs of the authors and fiction and literary works for
which no conventional publisher can be found. This suggests that non-profit-seeking
motives of the authors are the most important factors in the production of these books.
Nonprofit corporations also play an important part in publishing, especially (again) for
literary works, theology, politics, and research results. Most research results and literary
works from university scholars pay the authors nothing and many are published by
nonprofit corporations. Evidently motives other than direct profit -- including reputation,
which can lead indirectly to profit -- plays an important role in the supply of these
information products. Broadcast radio and television provide no-fee access to such
fabulously popular information products as the Super Bowl. Of course, the motive for this
supply is promotional, and the costs are borne by the sponsors. Many items of software and
other information products have been offered free on the Internet to be downloaded. (I
myself have administered a World-Wide Web site that offers economic material and a
guide to covered bridges without any expectation of any revenue from it. I can say that my
motivations have been a mixture of self-expression, reputation, and promotion, with
different mixtures for the different services on the server).

We should observe in passing that nonprofit publication can lead to differences in quality.
It is widely assumed that publications from subsidy publishers are of inferior quality.
Novels produced by profit-seeking publishers presumably are seen by the publishers as
having the promise of a large and profitable audience. On the other hand, when a novel is

6
O'Hare, Michael (1980), "A Malthusian Nightmare for the Composer and his Audience," Economic Policy
for the Arts, edited by Hendon, et. al (Cambridge, Mass: Abt Books) pp. 114-121.

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brought out by a subsidy publisher, it is possible that no-one other than the publisher thinks
it is any good. On the other hand, the quality considerations can go the other way. For
research results, the work is not published until one of more editorial consultants, with
expertise in the same field of research, have cleared it as being reliable. This is called "peer
review," since it is review by a person of equal expertise, a "peer" in research. A profit-
seeking publisher might be tempted to substitute popularity in the marketplace for this test
of scientific reliability. This probably accounts, in part, for the importance of non-profit
corporations in scientific publication (although profit-seeking publishers have also been
important in this field and seem to be growing moreso).

We have seen that "horse race" effects can lead markets to oversupply information
products, to the extent that profit motivations determine decisions to produce information
products. We have also seen that motivations other than direct profit may be important in
determining the supply of information goods. Both of these tendencies will to some extent
offset the tendencies toward underproduction we discussed in earlier sections. Both kinds
of tendencies will be present in many markets for information products. What sort of
balance can be expected? Will the tendencies toward overproduction just balance those
toward underproduction, leaving us back at the efficient output? That would be a
remarkable coincidence! In most cases an imbalance one way or the other is almost certain.
Will the tendencies to underproduction predominate, and only be partly offset by the
tendencies to overproduction, or will it go the other way around, so that information
products are overproduced?

If they are overproduced, then government policy to encourage the production of

information goods would just make the overproduction worse. In such a case, it would be
efficient for government to discourage the production of information goods, perhaps by
taxing them. In such a case, we might speak of "information pollution," and perhaps
regulations against excessive information production would be proposed. I do not know
that anyone has seriously proposed an information tax or regulations against excessive
"information pollution," but these would be efficient if information products were generally
overproduced.

Thus, the question -- which way does it balance out? -- is important for practical purposes
of determining what sort of government policy toward information we should have. In
practice, there probably is no general answer. In some cases, where intellectual property
rights are weak or missing, the medium itself a public good, horse race effects missing and
non-profit motives weak, as with Smith's lighthouse, there will almost certainly be
underproduction. In other cases, where intellectual property rights are fairly effective, the
medium a private or nearly private good, horse race effects important, and nonprofit or
indirect profit motives important -- as in the market for economics textbooks, we suspect --
overproduction is a real possibility. Moreover, the answers to these questions are not
permanent, either -- they are likely to change as technology changes.

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Chapter Summary

In this chapter, we have explored some aspects of the economics of information products
from the point of view of supply, demand, monopoly and competition and the role of
government in markets. As a first step we have defined an "information product" as a
collection of symbols which has utility because of the way the symbols are arranged.
Examples of such products include new inventions, books, and musical compact disks. We
have observed that information products have some special characteristics that set them
apart from other kinds of goods and services. 1) They cannot be sold alone but only jointly
with some medium of communication. 2) Each such product is unique. Information
products are not homogenous. 3) Fixed costs for such products are high, since only the
costs of the medium of communication are variable (and perhaps not all of them). 4)
Because they are easily and cheaply imitated, there may be a problem of insufficient
incentive to produce information products. 5) Intellectual property rights are instituted in
some cases to provide incentives that would otherwise be missing. All in all, this means
that markets for information products cannot be "perfectly competitive" (or in my
terminology, p-competitive) but may, in fact, be approximated by the cases of monopoly in
some cases and of public goods in other cases.

Many important aspects of markets for information products are illustrated by patents, a
form of intellectual property designed to protect those who invest in invention. Patents are a
second-best solution to this problem, and accordingly are granted for only a limited term.
Other forms of intellectual property share the difficulties we observe in the case of patents.
Information products are thus quasi-public goods, and in extreme cases may be public
goods. In such cases, profit-oriented private supply is very unlikely, and government
provision may be the only alternative to doing without. Adam Smith's lighthouse is an
instance of this.

These aspects of information products correspond to tendencies toward underproduction of

information products, relative to the economically efficient outputs of these products. But
there may be tendencies in the opposite direction as well. Where the rewards of production
of information goods go all, or predominantly, to the first or the best producer or to some
other individual producer selected on a winner-take-all principle, there may be tendencies
to overproduce information products. And it seems impossible to make any general
judgments as to which set of tendencies will be the stronger. Instead, it appears that each
particular information-producing industry would have to be investigated and evaluated on
the details of its operations. An active government policy of adjusting the production of
information would have to work differently in each case, and might have to be revised from
time to time as changing technology changes the detailed characteristics of the distinct
information goods. A conservative will have some doubts about the ability of government
policy to work that flexibly, while a committed liberal will hold that, imperfect as
pragmatic legislation may be, it is less imperfect than unchanging property rights and
inflexible laissez-faire. As the issue rests of the capability of government, it is really

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beyond the scope of economics finally to answer: we must defer to the political scientists
and philosophers at this point.

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