Chapter 4

INFORMATION, THE INTERNET, -COMMERCE,

AND FINANCIAL MARKETS

1. Information and Prices Frederick Hayek writes:

About the efficiency with which markets process information “to secure the best use of resources known to any member of society, for ends whose relative importance only these individuals know.”

Of the price system: ”The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly.”

1. Information and Prices – cont. Economic agents need only know the

prices of the things that are significant to them, for example: the professional investor who specializes in the relative prices of stocks, bonds and real estate.

Information is a scarce commodity. Some people make their living from

information, for example real estate brokers who know the locations and prices of homes.

2. Information Costs People are not perfectly informed about

prices today or in the future; they do not know exactly the qualities of the products they buy.

Information is a scarce and valuable commodity and it is costly because we have limited capacities to process, store and retrieve facts about prices, qualities, and location of products.

2. Information Costs – cont. Information costs are the costs, in

time and money, of acquiring information on prices today and in the future and on product quality.

We must choose among alternatives: goods, services and information. We must decide whether to obtain information ourselves or pay people who are specialized in economic information.

3. Information and the Internet

Buyers and sellers require information, and the cost of acquiring information affects how markets function.

The cost of information falls as technology improves.

The Internet was created in the 1960’s.

3. Information and the Internet – cont.

The Internet is a global network of networks that enables computers of all kinds to directly and transparently communicate and share services throughout much of the world.

This vast new technology brings together informed buyers and sellers in virtual markets.

3.1 Paying for the Internet

The Internet requires billions of dollars of investments in switching technology, mainframe computers, Web browsers, satellites, fiber-optic cables, large-capacity exchange points, routers and capacity circuits.

The federal government funded the early stages but now it is privately owned and operated.

The cost of the Internet must either be paid by someone or disappear.

3.1 Paying for the Internet – cont. The Internet meets the first criterion of

a public good “goods used by one consumer does not reduce the use of other consumers.”

Different options to pay for the Internet: 1. Charge consumers for information

downloaded.2. Advertising.3. The government can charge a monthly

fee, for example surcharge on phone/cable lines.

4. Virtual Markets A virtual market brings buyers and

sellers together in cyberspace via the Internet to make transactions and determine conditions of exchange.

The Internet has created these virtual markets (also called e-commerce or online shopping) and has markedly lowered the costs of information.

The traditional brick-and-mortar store where shoppers must be physically present is costly in time, transportation and money.

4. Virtual Markets – cont. Advantage of virtual markets for sellers

because of increased number of buyers: Higher prices – the greater the number of buyers,

the higher the price; Higher percentage potential buyers – especially for

rare or unusual products; and Buyers from all over the world – bid on goods and

services (eBay). E-commerce still accounts for only 2% share of

the total $4 trillion of retail sales. It has been most successful in book sales,

airline tickets sales, movie and concert tickets.

5. Intermediaries E-commerce has also decreased the earnings

of many intermediaries. In business transactions their must be a buyer

and seller, for this to take place these parties must be aware of each other’s existence.

Intermediaries specializes in information either:

to bring together the parties to a transaction or to buy in order to sell again.

Intermediaries are for example real estate brokers, department stores, etc.

5. Intermediaries – cont. Rarely is anyone forced to use the service of an

intermediary: therefore intermediaries must provide information at a lower cost than if the individuals involved had to gather the information themselves.

Intermediaries certify the quality of complicated goods, such as:

a reputable used-car dealer versus a fly-by-night car dealer;

major department stores that allows you to return defected purchased products; and

manufacturers with brand name products that certify quality.

6. Product Liability

The two views of product liability are: caveat emptor, “let the buyer

beware,” or buyers assume liability; caveat venditor, “let the seller

beware,” or the seller assumes liability. for product purchased.

6. Product Liability – cont. Caveat emptor has the following

advantages: Manufacturers provide consumers with an

incentive to gather information about product quality, durability, and safety;

If the seller were liable for all damages, the cost of the product could become excessive.

Manufacturers cannot anticipate all uses to which the product will be put.

7. Speculators

Speculators are intermediaries who buy now to sell at a higher price either immediately or in the future.

Speculators are pictured as scavengers.

7.1 Simple Arbitrage A speculator engages in simple arbitrage

by buying in a market where a commodity is cheap and reselling it in a market where the commodity is more expensive.

Arbitrage equalizes prices in different markets.

Arbitrageurs must act quickly and have sharp pencils and keen minds if they are to prosper.

7.2 Arbitrage through Time Arbitrage through time is buying a

commodity at a time when it is cheap and reselling at a time when it is expensive.

The speculator whishes to make a profit, but speculation will drive prices: up when they are low and down when they are high, and thus

stabilize both prices and production.

7.3 Profitable Speculation

Profitable speculation stabilizes consumption by reducing fluctuations in prices and consumption over time.

Profitable speculation shifts supplies from periods of relative abundance to periods of relative scarcity and stabilizes prices and consumption over time.

7.4 Unprofitable Speculation

Unprofitable speculation occurs when a speculator guess wrong, buys at a high price and must sells at a low price.

Unprofitable speculation is destabilizing because it shifts supplies from periods of relative scarcity to periods of relative abundance and amplifies movements in prices and consumption over time.

8. Intermediaries and the Internet The income earned by intermediaries

depends on the value of their information. If information about:

the availability of products; the location of buyers and sellers; and product quality and reliability

is widely available, intermediaries will be paid low prices and will disappear from the scene.

8. Intermediaries and the Internet – cont.

The Internet can provide buyers and sellers with massive amounts of information cheaply.

It is becoming a giant electronic intermediary populated by a large number of Web sites offering information to all who can log on.

9. Information About the Future: Financial Markets Financial markets are markets in which

financial instruments, such as stocks and corporate or government bonds, are bought and sold.

Shares of stock represent ownership shares of corporations. Once these shares have been issued, they are bought and sold (traded) on stock exchanges.

Bonds represent the debt of the issuing agency. They promised to pay the owner a rate of interest over the period of the bond’s existence, called its maturity.

9. Information About the Future: Financial Markets – cont.

Financial markets, in which stocks and bonds and other financial instruments are traded, provide information about the future.

Thus, buyers of stocks and bonds are speculators; even if they are small individual buyers earning modest incomes.

Speculation in financial markets takes place on the major stock and bond exchanges, where current owners of stocks and bonds consider whether to sell, and at what price, and potential buyers consider whether to buy, and at what price.

9. Information About the Future: Financial Markets – cont.

Stock prices are based on projected earnings per share and on interest rates.

Earnings per share equals profits divided by the number of shares.

Because expectations concerning future profits can change quickly, stock prices change frequently as well.

9. Information About the Future: Financial Markets – cont.

Movement in financial markets may be more meaningful that other measures of sentiment: A rising stock market means that we are

growing more optimistic bout our future. A falling stock market shows that a mood of

pessimism is spreading. When we buy or sell financial instruments we

are betting with our own money, and we take the time and effort to make the best choices possible.