Economic Perspectives on the Internet

The information technology sector of the United States economy, spurred on by the expansion of the Internet, has undergone explosive growth. According to a recent study by the University of Texas at Austin and Cisco Systems, the "Internet Economy" has led to the creation of over 1.2 million jobs, and generated over $300 billion in revenue (Barua, et al. 1999). In terms of user base, recent estimates project that by the end of 2000, 72 million Americans will have access to the web--up from 14.3 million in 1995 (Atkinson and Court 1998). The Internet, by all accounts, has drastically changed the manner in which business is done. Anything from material goods, such as groceries and compact discs, to information goods, such as database access and newspaper text, can be acquired with the ease of a mouse click or key stroke. The ease with which goods and services are purchased has corresponded to a dramatic expansion of web-based businesses, known generally as electronic commerce. One source has estimated that there were over 4.9 million commercial websites, as of December 1999, and that the number of commercial websites was growing in the last months of the year at a rate of almost 500,000 per month.1 This proliferation of commercial websites, as well as the potential profitability associated with such ventures, has motivated entrepreneurs to attempt to carve out niches in this new marketplace. Their activities have, in turn, also drawn attention from the legislative, executive, and regulatory arms of the government as they seek to understand this new medium, and its potential for both growth and misuse.A common question being voiced is: "What is the 'Information Economy'?" While it is easy for media commenators to claim the Internet has spawned a revolution that will redefine virtually all economic and societal relationships, as an economist, one might critically wonder what this "digital revolution" will mean for government enforcement policy.2 Does this new technology require economic practitioners to actually consider new theories in order to understand the internal workings of the digital market? Or is it the case, as Shapiro and Varian (1999) have argued, that "a few basic economic concepts go a long way toward explaining how today's industries are evolving." This essay will discuss some of the recent literature dealing with the economics of the Internet, focusing on the subjects of pricing of access to the Internet, pricing of goods sold via the Internet, network externalities, and Internet taxation. It attempts to present a succinct picture of the relevant literature, and offer some thoughts about the future development of the Internet, with respect to competition and consumer welfare. While none of the topics is covered in complete detail, this paper will hopefully provide the reader with enough information to serve as a roadmap of the current terrain in Internet-related economic matters, as well as a framework for future research endeavors.3 2 A recent report by the International Competition Policy Advisory Committee (International Competition Policy Advisory Committee 2000) noted several possible threats to competition, such as cartels and price signaling, that might follow from the expansion of E- commerce. While not offering any specific policy recommendations, the committee urged governments to be very attentive to the ongoing development of the e-marketplace, and to be ready to respond with appropriate antitrust enforcement measures. 3 The topics covered in this essay were selected for investigation primarily because of the sizable body of existing (and relevant) economic research. A non-exhaustive list of additional Internet-related topics might include commercial fraud, electronic payment systems, security and privacy of Internet transactions, copyright protection, and advertising strategies. For a treatment of several of these subjects, the interested reader is referred to Choi, Stahl and Whinston (1997).Section 1 will present a brief, relatively non-technical analysis of the current state of the Internet to help readers familiarize themselves with the technologies being discussed in subsequent sections. Section 2 will discuss current pricing practices for providing Internet access, as well as theoretical possibilities that have yet to be implemented. Section 3 will consider how the environment of the Internet, especially with respect to relatively low search costs and a variety of easy-access information, will shape the pricing of goods and services sold online. Section 4 will consider the network externalities literature and note how these theoretical models of network creation might apply to the current state of the Internet. Section 5 will move beyond theoretical and empirical studies and address a topic that has generated significant attention in the public as of late: taxation of online commerce. Finally, Section 6 will conclude with some general comments and a discussion of possible future areas of study.download