COURSEWORK»FINAL EXAM QUESTIONS

1. Gillette manufactures and sells shaving utensils. One of Gillette’s products is its "Mach3" (non-electric) shaver, which it sells at a rather low price. The Mach3 uses a special type of
shaving blade that comes in the form of a cartridge that one snaps on to the Mach3. The cartridges are rather expensive and it appears that Gillette may be the only company selling these cartridges, which are priced at approximately $1.50 each, which is rather expensive. When a customer first purchases a Mach3, several cartridges are supplied with the Mach3, but subsequently the customer must purchase replacement cartridges. Gillette recently introduced a companion product
for women that it calls the "Venus." Do the circumstances surrounding the Mach3 constitute a tying arrangement? Bundling? Given the facts presented above, what is a profit-maximizing pricing strategy for Gillette? Gillette sells the Mach3 and the cartridges primarily in drug stores, but it advertises them in mainstream media such as radio, TV, magazines, etc. Does this make the Mach3 an information good and therefore subject to the cost conditions and network  externalities that typically characterize information goods?

2. Priceline may or may not actually be earning a profit currently. Whatever the facts, what is Priceline’s business model? That is, how does it propose to make money? Who are its major competitors? What are its major problems?

3. The 8 February issue of the New York Times reported that some industries regard file-copyping
as good advertising that helps them rather than as an hostile action that will reduce their profits. Interestingly, the major example cited involved Playboy Magazine, which historically has published sexually explicit pictures and material.

(a) How could file-copying (e.g., the sharing of pictures) be good for Playboy?
(b) Can Playboy's example be generalized to all firms that are battling file-copying? Why or why not?

4. CantaMetrix is an encryption firm that has developed an advanced method for "fingerprinting"
digital music files such that one can tell whether a CD has been copied, and how many times it has been played. CantaMetrix says it has the capability to make the CD self-destruct if it has been copied illegally or played more than a predetermined number of times. CantaMetrix says its fingerprinting can be arranged so that a CD could be sampled or played several times (or a thousand times) before it self destructs and is useless. If such encryption technology is available, then why don't most or all information goods firms use it? That is, what's the downside to a firm that uses this technology?

5. Webswap is an auction firm that organizes Dutch auctions. Webswap auctions a variety of things
but most often it lists for sale garage sale types of items such as used furniture and the like. Webswap says that 95 percent of the items that it puts up for auction actually are purchased. Webswap has found that the higher the price it initially sets for an item, the higher the eventual price
for which it is likely to sell. "In fact, raising prices can attract buyers to junk," according to a New York
Times article (2 November 2000).

(A) How do buyers form their impressions about what is a reasonable price for an
item being sold on the Net and how might the auction process influence those impressions?
(B) What role, if any, does imperfect information have in this?
(C) In cases such as these, does the Net make markets more perfect, or less perfect? More efficient, or less efficient?

6. Several years ago, many knowledgeable individuals believed that the Net would reduce or even
eliminate intermediaries. Using the Net, consumers would deal directly with sellers rather than going through intermediaries who organize markets and bring buyers and sellers together. While the picture is mixed, in general, this has not happened to any great extent. Why not? What is the function of economic intermediaries? Why have intermediaries proliferated on the Net?

7. Noble Prize Laureate George Stigler famously uttered that "Ignorance is like subzero weather: by a
sufficient expenditure it effects upon people can be kept within tolerable bounds, but it would be wholly uneconomic entirely to eliminate all its effects."  What does the theory of search have to do with this? Explain.

8. Ronald Coase was the first economist to spend much time analyzing what has since become known as the "durable goods problem." Many information goods fall into this category. Explain. What strategies do information goods suppliers often use to combat this
challenge?

9. What determines whether or not a good is an information good? What difference will it make in
economic activity and behavior if a good is an information good rather than a regular good? Are information goods sufficient different that society should have separate laws and policies that apply to information goods as opposed to other goods?

10. Information goods are said to be ripe for third degree price discrimination because individuals often have highly individualized preferences for information goods. That is, you may be a fan of Sheryl Crow’s music, but I like Debussy, and therefore place very different values on these two goods than you do. What does this have to do with third degree price discrimination?
Explain.

11. Some information goods such as newspapers have a time dimension attached to them.

(A) So what?
(B) What innovations have occurred on the Net that take these things into account?
(C) Do these innovations increase efficiency?
(D) Information goods appear to be subject to significant economies of scale and economies of scope. Explain how and why.

12. In a perfectly competitive, frictionless market with homogeneous goods and perfect information, economic theory predicts that there will be only one price, not multiple prices, for a specific good or service. However, we typically observe many different prices for the same  good or service. Explain why. What effects does the Net have upon price uniformity?

13. Describe the precise economic circumstances under which it might pay a firm to give away some of its products.

14. What are the differences between "search goods" and "experience goods?" Which is more amenable to being sold on the Net? Why?

15. Two of the problems associated with conducting business on the Net are what economist term "moral hazard" and "adverse selection." Explain, using examples.

16. In the past few y ears, the U.S. Patent Office has begun to grant patents for "business methods" on the Net. For example, Amazon was granted a patent for its "1 Click" method of shopping such that customers can make a purchase with only one click of their mouse. This means that all other Net sellers must have at least two clicks in their sales process, or they are violating Amazon's patent.

(A) What is the economic rationale for granting patents?
(B) What are the costs associated with a patent system?
(C) How should we evaluate the worth of a patent?
(D) Should the "1 click" method be patentable?

17. How can firms "signal" the quality of their products by means of the Net? Do "bricks and clicks"
firms face different challenges than "bricks and mortar" firms in this regard? Why or why not?

18. Authoritative estimates suggest that only 50 percent of current dot.com firms are profitable, at least as economists calculate profitability.

(A) What does an economist mean when he/she says a firm is unprofitable?
(B) What single measure does an economist rely upon most often in order to determine if a particular dot.com might be a good investment?
(C) Why are so many dot.com firms unprofitable?
(D) If the profitability data are correct, what does this imply for the future?

19. Numerous dot.com firms, including Amazon, assert that they will be profitable at some time in the future. Suppose a dot.com firm (let's call it Koch.com) promises that it will generate the following revenues and costs over the next five years, after which it will go out of business and the value of its assets are zero:

Year Revenue Costs

1 $.5 million $2.0 million
2 $1.0 million $1.5 million
3 $1.5 million $1.0 million
4 $2.0 million $1.0 million
5 $2.5 million $1.0 million

Is Koch.com a "good" investment? Explain why or why not, being careful to make clear any assumptions that underpin your answer and to provide any calculations that lead you to your conclusion.

20. "Advertising is an expense and this means that sooner or later it must increase the prices that consumers pay." Do you agree or disagree? Why? How, if at all, does the Net influence your answer?

21. Barnes and Noble runs the Old Dominion University bookstore. It faces what marketeers often call "channel conflict."

(A) What is channel conflict and why has the Net accentuated it in many cases?
(B) What is the nature of Barnes and Noble’s channel conflict?
(C) Do the Detroit automakers face channel conflict? Why or why not?

22. Microsoft has frequently been accused of pursuing a  strategy of consumer "lock in" with respect to the sale of its software. Explain what this means and how it is related to Microsoft’s profits. Choose a Net firm other than Microsoft and demonstrate how it attempts to lock in its customers. Is
lock in a more significant phenomenon with information goods? Why or why not?

23. The 9 February 2004 issue of the New York Times contained an article dealing with the emergence of "social networks" on the Net such as Friendster.com and Tribe.net. These networks are all about social connections and are used by individuals for meeting people, socializing, dating, and some business purposes. Thus far, membership in these networks has been free, though some not have arisen that charge fees for membership and usage.

(a) With respect to the "free" networks, how do they expect to make money?
(b) With respect to the "fee" networks, how can they charge for something that others are giving away for free?

24. Price dispersion has not been diminished by the Internet and may actually have increased since the Net became popular.

(A) What are the major causes of price dispersion on the Net?
(B) What is the effect of advertising upon price dispersion?

25. The October 2002 antitrust settlement dealing with  Microsoft imposed a set of conditions upon Microsoft. One condition is that PC makers will be able to display icons on the screens of the machines they sell, whether or not the icons belong to Microsoft. Also, they automatically can boot up
a non-Microsoft product on their screens when users turn them on. Explain why these conditions may (may not) turn out to be important for competition in operating systems
and also in software.

26. What is "opt in" e-mail? Why is it more effective than ordinary e-mail advertising and messages? What do "click rates" have to do with this?

27. The Encyclopedia Britannica used to sell for about $2,000 per set, but now sells for only about $1,100 per set. Meanwhile, a few years ago, Britannica attempted to pursue a strategy of giving away much of its encylopedia over the Net, but no longer does that. Access can be purchased for $6.95 per month currently.

Explain the economic forces with which Britannica is contending and evaluate its prospects for survival.

28. Yahoo is one of the most popular (frequently visited) Web portal sites.

(A) What is a portal and what economic functions do portals fulfill?
(B) Yahoo does not charge people who visit its site. Explain how Yahoo makes money, or at least
hopes to make money.
(C) When Yahoo announced that Barnes and Noble would become its "premier" bookseller rather
than Amazon, meaning that B&N's site automatically will be presented to consumers who exhibit an
interest in a book, the value of value of Barnesandnoble.com went up $200 million (about 30 percent) in a single day (19 September 2000). What does this $200 million represent?

29. According to Wired Magazine’s October 2000 issue, the "brand value" of Coca-Cola was $72+ billion dollars.

(A) What is brand value and how might it be best computed?
(B) What economic difference does brand value make?
(C) What effects, if any, has the Net had upon  brand value?
(D) How do bricks and mortar firms attempt to use their brand value on the Net?

30. According to the Industry Standard, 27 March 2000, only 4.7 percent of visitors to e-commerce sites purchase anything and 63 percent of those who do make a purchase never make another purchase from that same firm. Recent data suggest that both of these numbers have diminished.

(A) What does branding have to do with this?
(B) What do portals have to do with this?
(C) Do these statistics suggest that e-commerce is unlikely ever to be profitable? Why or why not?

31. Theft of intellectual property is a major economic and legal issue on the Net. Explain how you would evaluate the economic loss suffered by a firm who:

(a) Has had a secret formula stolen from it.
(b) Has had its list of customers, their names and addresses, and purchasing history stolen from it.

32. "Free riding" by consumers using the Net has terrified bricks and mortar sellers. Ironically, the reverse also is true. Many Net sellers argue that consumers "free ride" them and bricks and mortar sellers benefit.

(A) Explain what each of the parties to this argument believes to be true.
(B) Can both of these arguments be true simultaneously?
(C) Whose argument do you believe is the strongest?

33. "Consumer data is the gold mine of e-commerce." (W. Whyman of Legg Mason, in the Washington Post, 18 February 2000.) Do you agree or disagree? Why?

34. What is a "cookie?" How does a Net firm such as Eddie Bauer use cookies? What does this have to do with price discrimination?

35. What is a "spybot?" How are most spybots  distributed? What is their purpose?

36. Data mining firms such as MicroStrategy and DoubleClick argue that the privacy concerns of some Net users are overdone and that soon the collection and use of information via the Net will be viewed in much the same fashion as most consumers view the use of their data on credit cards such as Visa and MasterCharge. That is, Net users will get used to it, not encounter major problems, and this will justifiably reduce their concerns. Is Net activity analogous to the use of credit cards in the bricks and mortar world? Why or why not?

37. What is a "shop bot?" What economic functions do they perform? Are these "good" functions from the standpoint of consumer’s surplus? How does a "bot" such as MySimon attempt to make money for those who sponsor it?

38. In class, I have suggested that one of the problems some Net intermediaries face is that if what they say is true and their economic model works, regular bricks and mortar firms may attempt to take this action away from the intermediaries and do these things themselves.

(A) Do you agree or disagree? Why?
(B) What conditions will determine whether or not this occurs?
(C) Why do intermediaries exist in the first place?

39. Overstock.com sells what it says is extra merchandise that other merchants could not sell (for a variety of reasons). For example, it will sell clothing and other items for prices well below those usually seen in bricks-and-mortar outlets.

(a) Who wins and loses when overstock does its thing?
(b) What is there about the Net that makes it especially useful for such activity?

40. eBay banned the auction and sale of Baseball World Series tickets in October 2000 (the "Subway Series") despite the fact that this auction area was "hot" and there were lots of buyers and sellers. eBay did so because there is a New York law that prohibits the resale of a ticket at more than 10 percent over their face value. If such auctions were legal, would they help both buyer and seller? Is ticket scalping a victimless crime? Explain.

41. Who actually owns information? Who should own information?  Why? Are there externalities attached to the ownership and use of information and, if so, what? If such externalities do exist, what difference should this make?

42. Spam e-mail is said to generate externalities.

(a) How so?
(b) When confronted with external economies and  diseconomies, what economic solutions do economists typically propose?
(c) How does Bill Gates' 2004 solution to spam fit into this
framework? (New York Times, 2 February 2004)

43. What is a "network externality?" Are information goods susceptible to network externalities? Does Intuit’s Quicken financial program generate network externalities? Why or why not? What about the use of the Linux computer language?

44. Metcalfe’s Law suggests that the value of a network can be approximated by N2, where N is the number of individuals using the network.

(A) What is the economic sense of this?
(B) What qualifications should be made to this formulation?

45. "There’s no doubt about it. The Internet lowers the prices that individuals pay."

(A) Do you agree or disagree? Why?
(B) What does empirical evidence suggest is true?

46. An executive of Ariba, a firm that produces software  used in electronic commerce, once commented that e-commerce and auctions aren’t necessarily fair. What did he mean?

47. Amazon's basic strategy has involved cutting prices, while eBay has raised its prices four years in a row. Both strategies may be profitable. Explain how this can be so.

48. "Ten years from now, there will be no more free music." Do you agree or disagree? Why?

49. CNET is a Net firm that says it has more than 16 million visitors monthly to its Web site. In contrast to other Net firms, CNET says it is profitable and will earn a profit of $12 million this year. CNET’s forte is providing high tech news, reviews of technology products, and price
comparisons. Recently, it acquired MySimon. CNET says its specialty is providing consumers with information about goods that are complicated and which are difficult for consumers to compare. CNET says that 60 percent of its revenues come from advertising. It now intends to extend its reach into other kinds of goods and services, for example, into automobiles and nontech items.

(A) Many Net firms attempt to diversify their activities into additional product lines. What dangers are present in such a strategy?
(B) What dangers exist for Net firms that make most of their money from advertising?
(C) Does CNET sell information goods? Why or why not?
(D) Is CNET an intermediary? Why or why not?
(E) What does CNET offer that might be superior to bricks and mortar alternatives?

50. How can it be that absolutely identical textbooks may be twice as expensive when purchased at an American bookstore than in Europe or Asia? Explain how and why this occurs. What effect has the Net had on this practice?

51. The Net has the potential to provide better service for some items, but probably provides worse service for others. Analyze which kinds of goods and services are likely to fall into each category.

52. One industry that appears to be in the process of being transformed by the Net is long-haul trucking. What is there about the long-haul trucking industry that makes use of the Net so valuable?

53. Explain what "packet police" or "packet shapers" are on the Net. What useful purposes do they serve? What dangers are inherent in the use of such things?

54. In many states, it is illegal for an individual to purchase wine over the Net and then have it delivered to their home. Wineries and individuals tend to be in favor or allowing such sales to occur, while wine wholesalers, retailer liquor and wine stores, and governments tend to be against such sales. Analyze who would win and lose if such sales were allowed.