Essay About Claims Of The Transformative Powers Of The Internet And Market Lessons

Market Lessons From The Internet
Essay Preview: Market Lessons From The Internet
Report this essay
Lessons About Markets from the
Internet
Glenn Ellison and Sara Fisher Ellison
Many of us have grown used to, tired of, and finally downright skeptical of
claims of the transformative powers of the Internet. It was to usher in
the New Economy, but we seem mostly to have the Old. It would
transform retail, but Toys R Us has outlasted EToys. Frictionless commerce would
be the norm, but plenty of friction still exists.
The Internet was also claimed to require a whole new economics with all new
laws. While this, too, was very far from the truth–existing theories have mostly
done quite well–the Internet has had a substantial effect on economic thought. In
this paper, we discuss some ways in which the Internet has affected how economists
think about markets.
That the Internet has affected economic thought is perhaps surprising. Some
economic events, like the Industrial Revolution and the inflation of the mid-1970s
and early 1980s, have had a major impact on the way economics is done. But other
major events, like the development of the interstate highway system and the 1987
stock market crash, seem not to have made much of a difference. For this reason,
we begin in the next section with a brief discussion of what about the Internet
seems to be making it important to economic research.
We then turn to our main task and discuss two specific topics that received a
lot of attention in the popular press and that have been viewed differently by
y Glenn Ellison is Professor of Economics and Sara Fisher Ellison is Senior Lecturer in
Economics, both at the Massachusetts Institute of Technology, Cambridge, Massachusetts. The
paper was written while the authors were visiting the Institute for Advanced Study, Princeton,
New Jersey, during 2003-2004, the former as a Member and the latter as the Richard B. Fisher
Member. Glenn Ellison is also a Research Associate, National Bureau of Economic Research,
Cambridge, Massachusetts.
Journal of Economic Perspectives–Volume 19, Number 2–Spring 2005–Pages 139-158
economists since the Internet boom: how the Internet was to create online
marketplaces and whether the Internet would usher in “frictionless commerce.” In
each case we describe how economists would have thought about these topics circa
1999, what actually happened and what lessons about the operation of markets have
been learned.
The Internet and Economic Research
The Internet has affected economic research along a number of dimensions.
Whenever a new phenomenon arises, especially one that receives so much attention
in the popular press, it will attract study by economists. We think that this fact alone
cannot account for the number of economists who have worked on the Internet
and the impact this research has had. In this section, we discuss briefly why the
Internet has helped economists develop new insights into the operation of markets.
First, the Internet has provided researchers with the opportunity to study how
markets function in novel and extreme circumstances. A vivid example is that with
the growth of the Internet, we suddenly have markets with essentially no search
costs. Price-search websites like Dealtime, Pricewatch and Shopper allow customers
wanting to purchase a particular book, a particular name-brand digital camera or
even a flower arrangement to receive a sorted and annotated list of price quotes
from dozens of retailers.
Why is this useful for research? Economists have long known that markets are
affected by consumer search costs, and empirical studies have tried to compare
markets with higher and lower search costs. It is difficult, however, to find examples
of two very similar markets where only search costs vary significantly. There are also
some striking theoretical insights–like Diamonds (1971) argument that there can
be a great discontinuity between markets with small incremental search costs and
those with no incremental search costs–that one cannot test by looking at markets
with low, medium and high search costs. Observing what happens when a
parameter–here the incremental search costs–takes on an extreme value can be
very informative.
Second, the Internet has provided a number of interesting natural experiments
for researchers to exploit. For example, in traditional retail markets, “identical”
products offered by different retailers were always differentiated by location,
customer service and idiosyncratic consumer preferences for a given store. With the
development of e-retail, products suddenly became differentiated by just the last
two of those. Comparing traditional and online retailers can thus