The Economics of Information Technology

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1 The Economics of Information Technology An Introduction The Economics of Information Technology is a concise and accessible review of some of the important economic factors affecting information technology industries. These industries are characterized by high fixed costs and low marginal costs of production, large switching costs for users, and strong network effects. These factors combine to produce some unique behavior. The book consists of the two parts. In the first part, Professor Varian outlines the basic economics of these industries. In the second part, Professors Farrell and Shapiro describe the role of intellectual property in these industries. The clarity of the analysis and exposition makes this an ideal introduction for undergraduate and graduate students in economics, business strategy, law and related areas. hal r. varian is the Class of 1944 Professor at the School of Information Management and Systems, the Hass School of Business, and the Department of Economics at the University of California at Berkeley. joseph farrell is Professor of Economics in the Department of Economics at the University of California at Berkeley. He has served as Deputy Assistant Attorney General and Chief Economist at the Anti-Trust Division, US Department of Justice, carl shapiro is the Transamerica Professor of Business Strategy at the Haas School of Business at the University of California at Berkeley. He also is Director of the Institute of Business and Economic Research, and Professor of Economics in the Economics Department at the University of California at Berkeley.

3 THE RAFFAELE MATTIOLI LECTURE SERIES... The Economics of Information Technology An Introduction... Hal R. Varian Joseph Farrell Carl Shapiro

4 University Printing House, Cambridge CB2 8BS, United Kingdom Cambridge University Press is part of the University of Cambridge. It furthers the University s mission by disseminating knowledge in the pursuit of education, learning and research at the highest international levels of excellence. Information on this title: / C Banca Intesa 2004 This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published th printing 2014 Printed in the United Kingdom by Clays, St Ives plc A catalogue record for this publication is available from the British Library ISBN Hardback ISBN Paperback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. Information regarding prices, travel timetables and other factual information given in this work are correct at the time of first printing but Cambridge University Press does not guarantee the accuracy of such information thereafter.

5 Contents List of figures The Raffaele Mattioli Lectures page vii ix Part I Competition and market power 1 1Introduction 1 2Technology and market structure 3 3Intellectual property 4 4 The Internet boom 5 5Differentiation of products and prices 12 6Switching costs and lock-in 21 7Supply-side economies of scale 25 8Demand-side economies of scale 33 9Standards Systems effects Computer mediated transactions Summary 46 Part II Intellectual property, competition, and information technology Introduction Patents, trade secrets, and copyrights Differentiation of products and prices Switching costs and lock-in 77 v

6 vi Contents 17 Standards and patents Do we need to reform the patent system? Summary and conclusions 85 Bibliography 87 Index of names 97 Index of subjects 99

7 Figures 1 Return on the NASDAQ and S&P 500 during the 1990s. page 2 2 Competition for an (a) ordinary and (b) perfectly price discriminating monopolist 29 3 Demand and supply for a network good 35 4 Price and shipments of fax machines 36 vii

9 The Raffaele Mattioli Lectures The Raffaele Mattioli Lectures, in which many prominent economists have taken part, were established in 1976 by Banca Commerciale Italiana in association with Università Commerciale Luigi Bocconi as a memorial to the cultural legacy left by Raffaele Mattioli, for many years chairman of the bank. Banca Commerciale Italiana then merged into Banca Intesa, which is pleased to continue promoting the new series of lectures together with Università Commerciale L. Bocconi. The aim is to create an opportunity for reflection and debate on topics of particular current interest, thus providing stimuli and ideas for the increasing challenges of a continually changing worldwide economic scenario. The present initiative is therefore dedicated to the analysis of the effects of important changes which are now taking place in the world economy: the globalization of markets, the continuous evolution in the field of information, technology and communications and the convergence of economics and international relations. It is evident that these changes, coupled with the European Monetary Union, provide many complex subjects that will be best dealt with from an interdisciplinary perspective. ix

10 x The Raffaele Mattioli Lectures Distinguished academics and researchers of all nationalities concerned with all kinds of economic problems will be invited to take part in this enterprise, with the intention of contributing to the debate interconnecting economic theory with practical policy.

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