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Information economics the economic impact of ebusiness

01/11/2012 20:22

Chartered Institute of Management Accountants


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Velocity 2011
Velocity August 2011
Information economics the economic impact of ebusiness

Information economics the economic impact of


ebusiness
August 2011

Adrian Sims of BPP Learning Media examines a new topic in the 2011 CIMA certificate level
syllabus, fundamentals of business economics (examinable from October 2011), for which he wrote
the syllabus. This article is also relevant to the enterprise pillar of the professional qualification.
The 2011 syllabus for fundamentals of business economics contains a number of new topics, intended to
ensure the relevance of the syllabus to the management accountant seeking to make sense of the current
business environment and the impact of this upon decisions. These new topics include globalisation, the
global banking crisis that commenced in 2007, and structural debt and government policy.
One other new syllabus component is the impact of advanced communication technologies (ACT) on
industries. It requires candidates to illustrate the potential impact on prices and competition of ebusiness
and is accompanied by the indicative content increased competition and lower prices from the impact of
ebusiness on costs of information search and by enabling low or zero variable cost.
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Information economics the economic impact of ebusiness

01/11/2012 20:22

The impact of ACT


Ebusiness is an outcome of ACT. This includes the internet, mobile telephone and data systems, digital
television, and network communications between firms using extranets and electronic data interchange.
They permit households, firms and other organisations to transmit and receive high volumes of data very
quickly and over substantial distances. They are accessed and supported by a new generation of hardware,
such as web books, smartphones, digital players, and home entertainment systems, and supported by smart
applications software known as apps.
ACT emerged in the late 1990s and in the past few years has taken a qualitative leap forward to become
known as web 2.0 solutions. This so called third industrial revolution is having a profound effect on
industries and the economic tools of analysis we use to understand them.
Locating price or product information
Compare buying some music or booking a holiday by conventional shopping and using ACT. Someone
seeking better prices incurs search costs such as time, telephone calls, and shoe leather.
ACT reduces search costs:
buyers and sellers can compare a wider range of prices using search engines and price comparison
websites
it reduces the costs of gathering additional information on the item by providing online samples of
movies, music and books, pictures and customer reviews of hotels and restaurants, and answers to
frequently asked questions.
In general the impact of greater pricing transparency through ACT should reduce prices in a market.
In economic terms it increases the price elasticity of demand:
1. The demand curve an individual firm faces will often become more elastic. Demand will extend
more readily when a supplier cuts its price because the number of customers spotting the lower
price and responding to it will be greater than with conventional commerce. Ebusiness agents such
as price comparison sites and auction sites facilitate this.
2. The market demand curve will also become more price elastic due to the greater availability of
substitutes. A new release DVD or CD now faces competition from downloads, which are
potentially cheaper and more convenient.

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Information economics the economic impact of ebusiness

01/11/2012 20:22

Impact of ACT on price elasticity of demand


In the diagram above, the conventional demand curve is shown as D. A supplier who cuts price from P0 to
P1 enjoys only a small extension of demand from Q0 to Q1. This is because the search costs the customer
incurs in finding the lower priced product outweigh the saving from buying at a cheaper price.
The demand curve when the market is served by ACT is shown by DACT. A supplier who cuts price from
P0 to P1 in this market enjoys a larger extension of demand from Q0 to Q2. This is because more
customers will be able to spot the lower price and switch to this supplier.
This helps explain the price competitiveness in the markets for insurance premiums, airline travel and
contact lenses, amongst others.
New supply and price relationships
In a conventional market, selling twice as much of something means the supplier must pay additional
variable costs to make the increased volumes required. ACT can change this to a situation where
producing extra units of a product that can be sold in digital format doesnt require much or any increase
in variable costs at all.
For example the costs of downloading books, newspaper, music, films or software are born as data
charges by the customer. The supplier incurs high fixed costs to establish the content and download, but
across fairly large increases of output, costs do not rise with output and supply becomes perfectly price
elastic.

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Information economics the economic impact of ebusiness

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Impact of ACT on market price


The demand curve makes the simplifying assumption that consumers are equally happy with the
conventional product and its digital version. The supply curve Sc denotes the supply curve of the
conventional producer. Its upward slope reflects the rising total variable costs of a conventional
production process. Market price is established at Pc with quantity sold at Qc.
The supply curve SACT denotes the supply curve of the producer using ACT. It is flat because variable
costs are zero and hence costs do not rise with output. Market price is established at PACT with quantity
sold at QACT.
The extent to which ACT brings about the fall in price and rise in consumption denoted will depend on a
number of factors:
(a) The nature of the product. ACT reduces prices more where the product is a commodity product, ie
where it is a standard product of known specification such as a CD or book. It is less effective if the
product is differentiated, such as a wedding dress or a piece of fine art.
(b) The price elasticity of demand for the product. For an ACT producer to benefit from cutting price
demand needs to be price elastic.
Although we said earlier that ACT will often increase the price elasticity of demand, there are some
situations where price elasticity will remain minimal.
Reducing the price of the ACT version of an eagerly awaited novel or music release is unlikely to increase
revenue. This is because there are unlikely to be sufficient additional readers buying a download of the
book to compensate for the revenues lost from not selling the book at a higher price to fans.
(c) The degree of control over market supply. In the figure above it is assumed that the market price is
determined by one producer and that this producer decides the market price.
Where supply is more competitive and there is limited product differentiation (such as competing
magazines or video games), competition may drive the price down. The strength of intellectual property
right protections will be a factor here.
(d) The degree of differentiation between ACT platforms. The demand for some products is affected by
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Information economics the economic impact of ebusiness

01/11/2012 20:22

complements. The video game market features a small number of console producers (Sony, Nintendo, and
Microsoft).
These consoles play the same video games as each other, but the console software means that software
producers have to develop a special version for each console. A version of the game software, say for a
Nintendo, cannot then be played on a Sony PlayStation. This has the effect of increasing the ability of the
platform owner to decide price and supply.
Conclusion
The new C04 syllabus requires candidates to apply economic analysis to the modern phenomenon of
ebusiness. If we reflect on the very sharp falls in the prices of motor insurance, recorded music and films,
we can accept that some of this is due to the huge reduction in the costs of searching for and producing
these.
Links
Specimen questions for C04
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