The economics of digitization is the field of economics that studies how digitization, digitalisation and digital transformation affects markets and how digital data can be used to study economics. Digitization is the process by which technology lowers the costs of storing, sharing, and analyzing data. This has changed how consumers behave, how industrial activity is organized, and how governments operate. The economics of digitization exists as a distinct field of economics for three reasons: it studies a world that is digital, exponential and combinatorial. First, new economic models are needed because digital goods have very low or even zero marginal costs unlike most traditional goods, thus many traditional assumptions no longer hold in a digitized world. Second, the rate of improvement of computers, networks and other engines of digitization, is exponential, as reflected by Moore's Law. Third, digital goods can easily be combined and recombined, increasing their value not only via networks and platforms, but also novel combinations. Each of these effects is important individually, but together they have synergies and constitute a distinct economic landscape.
Research in the economics of digitization touches on several fields of economics including industrial organization, labor economics, and intellectual property. Consequently, many of the contributions to the economics of digitization have also found an intellectual home in these fields. An underlying theme in much of the work in the field is that existing government regulation of copyright, security, and antitrust is inappropriate in the modern world. For example, information goods, such as news articles and movies, now have zero marginal costs of production and sharing. This has made the redistribution without permission common and has increased competition between providers of information goods. Research in the economics of digitization studies how policy should adapt in response to these changes.
The field is relatively new. The National Bureau of Economic Research created their first workshop on the Economics of Information Technology and Digitization in 2011, with sessions on digital advertising, digitization and productivity, and related topics.
Information technology and access to networks
Technological standards
The Internet is a multi-layered network which is operated by a variety of participants. The Internet has come to mean a combination of standards, networks, and web applications (such as streaming and file-sharing), among other components, that have accumulated around networking technology. The emergence of the Internet coincided with the growth of a new type of organizational structure, the standards committee.Mowery, D. and Simcoe, T. 2002. The Origins and Evolution of the Internet, in R. Nelson, B. Steil and D. Victor (eds), Technological Innovation and Economic Performance. Princeton, NJ: Princeton University Press, pp. 229–64. Standards committees are responsible for designing critical standards for the Internet such as TCP/IP, HTML, and CSS. These committees are composed of representatives from firms, academia, and non-profit organizations. Their goal is to make decisions that advance technology while retaining interoperability between Internet components. Economists are interested in how these organizational structures make decisions and whether those decisions are optimal.
The supply of Internet access
The commercial supply of Internet access began when the National Science Foundation removed restrictions for using the Internet for commercial purposes. During the 90's internet access was provided by numerous regional and national Internet service providers (ISPs). However, by 2014, the provision of high-speed broadband access was consolidated. About 80% of Americans can only buy 25 Mbit/s from one provider and a majority only have a choice of two providers for 10 Mbit/s service. Economists are particularly interested by competition and network effects within this industry. Furthermore, the availability of broadband may affect other economic outcomes such as the relative wages of skilled and unskilled workers.Akerman, Anders & Gaarder, Ingvil & Mogstad, Magne, 2013. "The Skill Complementarity of Broadband Internet," IZA Discussion Papers 7762, Institute for the Study of Labor (IZA).
Demand for the Internet
A key issue in the economics of digitization is the economic value of Internet-based services. The motivation for this question is two-fold. First, economists are interested in understanding digitization related policies such as network infrastructure investment and subsidies for Internet access. Second, economists want to measure the gains to consumers from the Internet. The revenues of Internet Service Providers provided one direct measure of the growth in the Internet economy. This is an important topic because many economists believe that traditional measures of economic growth, such as GDP, understate the true benefits of improving technology. The modern digital economy also tends to lead to reliance on inputs with zero price.
The effects of digitization on industrial organization
Platforms and online marketplaces
Digitization has coincided with the increased prominence of platforms and marketplaces that connect diverse agents in social and economic activity. A platform is defined by Bresnahan and Greenstein (1999) as "a reconfigurable base of compatible components on which users build applications". Platforms are most readily identified with their technical standards, i.e., engineering specifications for hardware and standards for software. The pricing and product strategies that platforms use differ from those of traditional firms because of the presence of network effects. Network effects arise within platforms because participation by one group affects the utility of another group. Many online platforms replicate identical process or algorithms at virtually no cost, allowing them to scale the network effect without encountering diminishing returns. Large scale network effects make the analysis of competition between platforms more complex than the analysis of competition between traditional firms. Much work in the economics of digitization studies the question of how these firms should operate and how they compete with each other. A particularly important issue is whether markets for online platforms have a tendency towards "winner-takes-all" competitive outcomes, and should be subject to antitrust actions.
Online platforms often drastically reduce transactions costs, especially in markets where the quality of a good or trading partner is uncertain.Douma & Schreuder, Economic Approaches to Organizations, 6th edition. Harlow: Pearson For example, eBay drastically increased the market for used consumer goods by offering a search engine, reputation system, and other services that make trade less risky. Other online marketplaces of this type include Airbnb for accommodations, Prosper for lending, and Odesk for labor. Economists are interested in quantifying the gains from these marketplaces and studying how they should be designed. For example, eBay, Odesk, and other marketplaces have adapted the use of auctions as a selling mechanisms. This has prompted a large literature on the comparative advantages of selling goods via auction versus using a fixed price.Bajari, P. and A. Hortaçsu. 2003. The winner's curse, reserve prices, and endogenous entry: empirical insights from eBay auctions. RAND Journal of Economics, 34 (2, Summer), 329–55.Einav, Liran and Farronato, Chiara and Levin, Jonathan and Sundaresan, Neel, Sales Mechanisms in Online Markets: What Happened to Internet Auctions? (May 2013). NBER Working Paper No. w19021.
User-generated content and open source production
Digitization has coincided with the production of software and content by users who are not directly compensated for their work. Furthermore, those goods are typically distributed for free on the Internet. Prominent examples of open-source software include the Apache HTTP Server, Mozilla Firefox, and the Linux operating system. Economists are interested in the incentives of users to produce this software and how this software either substitutes or complements existing production processes. Another area of study is estimating the degree to which GDP and other measures of economic activity are mis-measured due to open source software. For example, Greenstein and Nagle (2014) estimate that Apache alone accounts for a mis-measurement between $2 billion and $12 billion.
In addition, open source production can be used for hardware, known as open hardware, normally by sharing digital designs such as CAD files. Sharing of open hardware designs can generate significant value because of the ability to digitally replicate products for approximately the cost of materials using technologies such as 3D printers.
Another active area of research studies the incentives to produce user-generated content such as Wikipedia articles, digital videos, blogs, podcasts, etc. For example, Zhang and Zhu (2011) show that Wikipedia contributors are motivated by the social interaction with other contributors. Greenstein and Zhu (2012) show that while many Wikipedia articles exhibit slant, the overall level of slant across articles on Wikipedia has diminished over time.
Advertising Advertising is an important source of revenue for information goods, both online and offline. Given the prevalence of advertising-supported information goods online, it is important to understand how online advertising works. Economists have spent much effort in trying to quantify the returns to online advertising. One especially interesting aspect of online advertising is its ability to target customers using fine demographic and behavioral data. This ability potentially affects the ability of new and small firms to gain exposure to customers and to grow. Targeted advertising is controversial because it sometimes uses private data about individuals obtained through third-party sources. Quantifying the costs and benefits of using this type of data is an active research area in the field.
The effects of digitization on consumer choice
Search, search engines and recommendation systems
Perhaps the oldest and largest stream of research on the Internet and market frictions emphasizes reduced search costs. This literature builds on an older theory literature in economics that examines how search costs affect prices. Digitization of retail and marketing meant that consumers could easily compare prices across stores, so the empirical work on Internet pricing examined the impact on prices and price dispersion. Initially hypothesized by Bakos (1997), the first wave of this research empirically documented lower prices, but still substantial dispersion.
The newest wave of this research collects data about online searches to examine the actual search process that consumers undertake when looking for a product online.Baye, Michael R., Babur de los Santos, Matthijs R. Wildenbeest, 2013. Searching for Physical and Digital Media: The Evolution of Platforms for Finding Books, in A. Goldfarb, S. Greenstein and C. Tucker, Economics of Digitization: An Agenda. National Bureau of Economic Research.Fradkin, Andrey. 2014. Search Frictions and the Design of Online Marketplaces. Working paper, Stanford University. This question also emphasizes that the final stage of purchase is often controlled by a more familiar retail environment, and it raises questions about the growing importance of standards and platforms in the distribution of creative content.