This column is devoted to one of the most profound, yet underestimated concepts in economics: value. At a time when services on the Internet are dominated by ‘free’ services and with populist governments in many parts of the world, the central role of prices in markets has changed significantly.
First, background. High school economics reminds us that the price of a good or service is what ‘clears’ supply with demand. Graduate level economics would refine this to the clearing price at which marginal benefit (to the consumer) equals marginal cost (to the supplier). While this is true, it downplays the phenomenal importance of simple intangible value. Prices serve at least four important functions. Prices determine which goods and services are to be produced (capital allocation) and in what quantity (supply function); They determine how to produce objects (method functions); And fourth, they determine who will receive the goods (payment gate). A simple way to restate this is to think of the role of prices as being similar to the role of genes in the human body; They hold all the information necessary for both suppliers and customers to organize their activities for continuous and independent continuity.
If you think about prices in this way, the distortions and opacity in prices introduced into the internet economy and compounded by governments giving wide freebies leads to a very messy economic system. This messy system, devoid of informational clarity of prices, leads to less competition, less innovation and ultimately lower consumer welfare. Take the case of Google Search and how much you would like to be compensated for giving access for a month. In a 2019 NBER academic paper, Brynjolfsson et al estimated a way to study the consumer welfare contribution of these ‘free’ services using large-scale online choice experiments. They estimated that the average US consumer would need to pay $17,530 annually in compensation for giving up access to Google Search. By offering search results for ‘free’, Google has chosen to monetize the service by charging advertising customers very high rates to advertise. If customers were to pay $10,000 a year in exchange for having their information completely firewalled from other Google customers, Google would effectively be out of business.
For governments, the implicit packaging of full or partial subsidies into the price of a good or service distorts the market system and leads to misallocation of resources and often fraudulent behaviour. Take the case of cooking gas in India, earlier the subsidy in the price of the cylinder was abolished. In that earlier system, the unclear market price of gas cylinders led to excessive use by those ineligible for subsidies, additional prices for those buying gas in the open market, and an idle production function for producers, who were losing money on each cylinder. . The new method is cleaner, with a unit price for cooking gas, and a parallel and targeted payment track followed by government subsidies reaching households that are unable to afford the market price.
Economists define a ‘public good’ as a good that satisfies two conditions: 1) the consumption of such a good by one person does not subtract from the consumption of another person (it is non- opponent); and 2) consumers cannot be excluded from consuming that good after it has been produced (it is non-excludable). National security is a perfect example of a public good, as is street-lighting.
Those goods which are competitive and excludable are called private goods. Contrary to intuition, public goods can be provided by both the government and the private sector, and similarly private goods can be provided by anyone. An example of a private good often provided by governments is transportation, which contains elements of both exclusion (ticket price) and rivalry (limited train capacity).
The problem for policymakers is that the Internet and other forms of digital infrastructure are not easily classified as one or the other. Really the way these digital services operate is to offer something for free to attract users. Once acquired, the entity monetises the user base with some other service. The power goes to the companies that have the largest base of customers, for whom many services can be pushed beyond what is offered free of charge. This has the unintended consequence of creating an oligarchy. It is difficult to spot cross-subsidies and cross-profiting.
As has already begun in the European Union (EU), regulators will have to increase scrutiny of anti-competitive outcomes and concentration of data in the hands of a few entities as a result of non-transparent and cross-product pricing strategies. Where the informational signal from the price for each of the underlying products is ambiguous, regulators will have no choice but to break down customer concentrations.
Even though consumer welfare is increasing in areas where services are being offered free of cost, it is simultaneously eroding in other areas where individual privacy is being compromised.
Price will be an emerging battleground in this era.
PS: “The cost of anything is the amount of life you exchange for it,” said Henry David Thoreau.
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