Economics of Information

views updated


Though economists often talk in terms that seem impenetrable, what they study is very simple and basic. The "economy" is how resources are distributed throughout society. Since the 1960s, the world has been described as an information economy, rather than an industrial or agricultural economy. Buying, selling, and using information are at the heart of economic activity for businesses and consumers, as well as for the governments that regulate them.

Development of the Field

In ancient hunter-gatherer or small-scale agricultural societies, most economic activity was governed by tradition. When a global economy first began to develop in the fifteenth and sixteenth centuries, however, the need to plan for activities that would be coordinated over vast distances and the need to account for the effects of weather and events in faraway places on domestic availability of food and goods led to the articulation of theories about how the economy works. Each subsequent change in the nature of the economy has similarly stimulated the development of new economic ideas, first with industrialization and then with "informatization."

The subfield of the economics of information emerged as several distinct strands of research and theory that dealt with very different aspects of information began to be considered together. Neoclassical economic theory, the economic ideas that dominated most of the decision making (whether of government or of corporations) during the twentieth century started from a set of five assumptions: (1) that everyone has access to the same information, (2) that everyone has perfect information about prices and goods in the marketplace, (3) that purchasing decisions are made solely for economic reasons, (4) that the histories and habits of consumers have no influence on individual buying decisions, and (5) that power and influence play no role in how the market works. Historical work that contributes to the way in which economists understand information dealt with matters as different from each other as optimization of flows through a communication system, decision theory, research and development, prices, organizations as economic entities, and risk.

Over the course of the twentieth century, however, the growth in the importance of information goods and services to the economy forced reconsideration of many of these inherited economic ideas. In the 1930s, Ronald Coase pointed out that the very reason corporations form is to reduce the transaction cost (i.e., the cost of getting knowledge about prices for necessary things). One important implication of this insight, he noted, was that businesses should not be seen as solid and stable structures; rather, they should be seen as incompletely connected networks of information flows. By the 1960s, Fritz Machlup and Kenneth Boulding started identifying industries that fell within the "information sector" of the economy. In the 1970s, Uri Porat offered a framework for statistically analyzing trends in the information sector. This framework was taken up by the U.S. government and subsequently by other governments around the world, leading to the creation of the body of statistics related to the enormous growth in the percentage of the work force involved in "information work," the contributions of information industries to the national economy, and so on.

Subsequently, a great deal of work began to be done to investigate how neoclassical economic ideas applied to information creation, processing, flows, and use. A number of problems were identified. It is difficult to break information into units, so it is therefore difficult to quantify it. Information is not appropriable; while it can be owned, that ownership is rarely exclusive. Information is thus said to be "leaky" because when it is transferred it may go not only from seller to buyer but also to third parties who may be in the vicinity and acquire the information solely through, for example, overhearing it, viewing it from afar, or accessing it through web-based means. Information is heterogeneous in nature, so it often is valued in widely differing ways by different people. This is illustrated by the fact that "old" information is useless to corporate decision makers, but it is invaluable to historians. In most cases, value is put not on information itself but in its material packaging—the book, the classroom, or the television set. Economists use the term "commodities" to identify things that are bought and sold that are fixed in time and space, but informational goods and services are not necessarily fixed in time and space. Where, for example, would one locate the site of the purchase of information processing in a transaction that involves a buyer in one country, a seller in a second, and a computer in a third? Despite these problems, it has been necessary to come up with some way of understanding economic processes as they take place within an economy that is (1) clearly ever-more reliant on information technologies for the production, distribution, and use of all kinds of goods and services and (2) composed of an ever-larger proportion of informational goods and services.

What Is "The Information Economy"?

The earliest way of understanding the information economy was set forth in the 1960s. According to this product-based theory, an information economy operates just like any other economy except for the simple difference that there is a larger proportion of informational goods and services being bought and sold. This approach continues to underlie most governmental decision making, and it is the approach that is used to generate statistics to describe the growth of the information economy. This approach is useful as far as it goes, and it has the advantage of permitting decision makers to continue to work with the kinds of analytical tools that they have always used. However, people in the business world increasingly began to feel that this approach did not adequately capture what was going on in the contemporary economy—where value was being created and money was being made.

By the 1970s, some people began to look for an alternate understanding of the information economy because of the problems that were associated with treating information as a commodity and with the social inequities that resulted from differential access to information. This led to a domain-based theory that said the information economy resulted from the expansion of the boundaries of the economy itself through commodification of forms of information that had never before been treated as a commodity. Some of the forms of information newly commodified could be public, as when governmental databases such as those generated by the U.S. satellite surveillance system are turned over to the private sector. Some of it is private, as in the example of the details of one's personal life that are now bought and sold. Again, there is some truth in the insights offered by this approach. However, it has been limited in its influence upon policymaking because it has not offered alternative analytical tools that can help policymakers solve problems.

In the early 1990s, a third way of defining the information economy appeared, focused not on products or on the domain but on how the economy functions. Led by Cristiano Antonelli, proponents of this approach argue that the contemporary economy is an information economy because it operates in qualitatively different ways from how the economy operated in earlier stages. Antonelli and others argue that in the information economy, cooperation and coordination are as important as competition for long-term economic success. Because different types of economic, political, and social entities are so intertwined in all of their activities, these economists argue that there is little that actually still takes place in the market as idealized by the neoclassical economists of the late nineteenth century. Rather, most economic activity takes place via the "harmonization" of different types of information systems with each other.

While all three of these perspectives are used to support decision making by various groups, both public and private sector decision makers are gradually shifting from the most traditional approach to an appreciation of the unique informational features of what many now call the "net-work economy." Corporations are changing because they are finding that traditional ways of thinking do not account for what they are experiencing. Governments are changing in order to remain competitive with other types of organizations—such as transnational corporations—in contemporary struggles for power.

Economic Analysis of Information

Information is important economically both as a good (i.e., an object that can be bought and sold, such as a book) and as a service (i.e., a process that can be bought and sold, such as data processing). One of the reasons it has been so difficult to deal with information in economic terms has been that it is more difficult to deal with the economic features of commodities that are intangible than with those that are material, or tangible.

Consumers tend to think most of primary or final information goods and services, those that are bought by users in the form in which they are produced. Movies, television programs, databases, books, and magazines are all examples of information as a final good. In the contemporary economy, however, informational goods and services are also important in secondary or intermediate form, meaning that they are not products bought and sold in the retail market. Rather, they are inputs into the production of other types of goods and services. For example, data about marketing and sales trends is an important input into the production of goods for sale. Data about the functioning of the global information infrastructure through which the communications of the Internet flow is another example of information as a critically important secondary good. Information as a secondary good may be in the form of raw data, as in these examples. It is also said to be embedded in advanced technologies that embody information because they are the outcome of lengthy research processes that produce information. It is also embedded in the people who use those technologies as a form of what is called "human capital."

One of the first problems economists faced in thinking about information was defining the information sector of the economy (i.e., those industries involved in working with information) so they could be analyzed separately from other types of economic activities. This is not a problem with a precise and fixed solution because many companies are involved in both information-based and materials-based businesses and new information businesses are being created all the time. Generally, the information sector is defined as those industries that have a primary focus of producing, distributing, processing, or storing information. Important examples of industries that belong to the information sector include education, media (e.g., television, radio, book and magazine publishing, and film), Internet companies, telephone companies, libraries, database providers, and data processors.

It is precisely because so many new businesses are being created all the time that it is difficult to draw clear lines between different information industries. For example, a film archive may become a content producer, a law firm may launch a data processing venture, and a radio station may make money transferring data files as a side business. Furthermore, many of the new types of businesses that are emerging, such as Internet service providers and cable television, do not quite fit into the previously standard ways of categorizing industries.

Historically, an economic analysis of an industry would have focused on the activities of individual corporations, what economists call the "firm." Accounting systems—and the governmental regulation for which they provide the frame-work—have long been in place, and they support the continued reliance on such an approach. However, economists are developing analytical techniques that look at the long-term project rather than the firm as the unit of analysis because so much activity in the network economy takes place not within single firms but within a network of interdependent organizations of different types that interact in a multitude of ways.

The Information Production Chain

The fundamental principle of the economics of information is that value is added every time information is processed. Donald Lamberton, a key figure in the development of the subfield, points out that the division of labor involved in information processing—the way in which processes are broken up into small pieces for handling—may be the most fundamental form of the division of labor. Awareness of this has led to the use of models of an "information production chain" as a way of identifying the different points at which value is added and as a means by which information commodities can be distinguished from each other.

While different industries and governments break up the steps of the information production chain in different ways, work by Machlup and Boulding suggests a basic model that includes the following stages: information creation (de novo, or through generation or collection), processing (algorithmic [computerized] or cognitive [human]), storage, transportation, distribution, destruction, and seeking. Those who think about the informational value of production chains for other types of goods and services often think of each stage of manufacturing and distribution as spinning off an informational "value chain."

This emphasis on distinctions among types of information processing as a source of economic value has another consequence, exacerbated by the fact that ongoing technological innovation processes continue to offer new opportunities to entrepreneurs. Though, historically, analysis of functions within the firm were organized around the product, the task, or the job description, economists, led by Roberto Scazzieri, are learning to analyze activities within individual and networked firms in terms of their processes. Thinking in terms of an information production chain also heightens awareness of the value of information as a resource.

Creating Information Goods and Services

In the agricultural and industrial economies, fundamental resources were material. In order to have more (whether it was, for example, land, oil, or iron ore), more had to be found physically, or new ways of getting at known resources had to be invented. In the information economy, however, the discovery of new resources is conceptual. Distinctions among types of information processing and the informational states they produce must be understood in a new way so that a new type of product or service niche becomes available. It is this emphasis on thinking as a way of creating new products that has made it possible for so many young people to have succeeded so well in information businesses. In the past it might have taken years for an entrepreneur with a good idea to accumulate the needed capital and capacities, but today, even someone who is very young can come up with a new way of thinking about ways to create, process, distribute, and use information and turn that into a business.

Creativity is needed in order to form a successful information-based business, but economists are able to offer a number of basic generalizations regarding how best to think about information from a business perspective. These approaches begin by segmenting the market into different niches, each of which can be served with a different product. Marketing equipment and software for web access to the elderly population that would use it primarily for family correspondence, for example, might stress features that would be very different from the ones emphasized in marketing the same equipment and software to teens who might be more interested in games, music, and other web-based activities. Through product differentiation, different products are developed for each niche. Versioning, or developing several different versions of the same product, is a popular approach to product differentiation for information goods and services. A different version can be developed for each market segment. If such a breakdown is not evident, information economists Carl Shapiro and Hal R. Varian suggest that a business should create three versions because psychologically, the market will at the least break down into those segments that are attracted to each of the extremes and to the central choice. Versions can be distinguished from each other along a number of dimensions, depending on which are most important to the specific good or service involved. Shapiro and Varian identify the following as possibilities: delay, interface (e.g., nature of and ease of use), convenience (e.g., how long does it take to learn to use it, how troublesome is it), image resolution, speed of operation, flexibility of use, capability, features and functions, comprehensiveness, annoyance, and support.

The cost of producing information is independent of the scale on which it is produced; that is, the cost of producing information is the same whether it results in one commodity for sale or a million. The difference between the "first unit cost" and subsequent reproduction means that there can be enormous "economies of scale" in the information industries. This is the reason for the economic appeal of mass market products such as television programs, films, and books to those who produce and sell them.

The features of information technologies are critical to understanding the economics of information. Two features worth mentioning here are those of "lock-in" and "network externalities." Lock-in reflects the fact that the "sunk costs" involved in building any specific communications network are so high that it is hard to change technologies once the network is built. (This is also called "path dependence.") Lock-in makes decision making even more difficult during a period in which innovation is constant and experience with existing and new technologies is so thin that it is difficult to know how to evaluate various technologies relative to each other. One way to reduce the risks associated with lock-in is to respond to network externalities (i.e., the characteristic that the greater the number of individuals and organizations using a network good or service, the greater will be the value of that service). The greater the market for an informational product, the more likely it will be that users will develop an experiential base that facilitates use, that maintenance systems will be in place, and that complementary goods and services will be available.

Lock-in also facilitates what antitrust law refers to as "tying" and those in the information industries refer to as "bundling"—linking together different informational goods and services for joint purchase and use. One of the discoveries of experimentation within the newly emergent information economy has been that many types of informational goods previously thought of as discrete and unique entities can themselves be "unbundled," or broken down into their parts, for separate sale and use. Vendors of magazines, for example, have realized that in the digital environment they can sell article titles, summaries, texts, references, and tables of contents separately. A very famous example of unbundling was the result of the 1983 insistence by the antitrust division of the U.S. Department of Commerce that AT&T divest itself—separate off and sell—local telephone services, which had always historically been bundled with long-distance telephony in one service package.

While ownership of material goods, land, capital, and resources remains important in the information economy, many would say that property rights in information and ideas have become the most important form of property. Intellectual property rights law determines the nature of property rights in information. In the United States, there are several different types of intellectual property. The most important are copyright (i.e., ownership of the expression of ideas), patent (i.e., ownership of the expression of ideas in an invention), trademark (i.e., the right to control the use of symbols), and working papers (i.e., privacy for and control over the results of information processing conducted in the course of completing a work process).

Policymakers struggle with adapting the intellectual property rights system to the contemporary technological environment. It has been difficult, for example, to figure out just how to deal with computer software from an intellectual property rights perspective. Should it be covered by copyright or by patent? Which kinds of software programs should be available to everyone and which kinds should have to be purchased? These problems are made even more difficult by the need to reach international agreement on these matters, since the global nature of the information infrastructure means that property rights issues that arise anywhere are global in nature.

The Limits to Information as a Commodity

While both governments and corporations make policy based on economic analyses of information and the processes by which it is created, stored, distributed, and used, the same matters can be analyzed from political, social, cultural, or ecological perspectives. The greatest value can be derived from economic analyses when they are placed within the wider context. From this point of view, the weaknesses as well as the strengths of the economic approach can be identified.

One of the most striking features of the last half of the twentieth century was the way in which forms of information never before treated as economic goods and services were commodified, or turned into something that could be bought and sold. Examples of such newly commodified forms of information include those that are most private, such as what thoughts are in one's mind, or what chemicals are in one's urine. They also include those that had historically been most public, such as databases put together by governments in order to serve the public interest or the traditional stories that ensure survival of ancient cultures. The fact that such forms of information can be com-modified, however, does not mean that they should be. Growing numbers of economists, policymakers, and communities have begun to realize that the pursuit of the economic value of information must be balanced with the pursuit of other types of important value. Even when information is treated as a commodity, it remains important in other ways—as knowledge structures and as a constitutive force in society. Information is critical to the social construction of reality—to the ways in which people together build the social world. Information policy for a thriving political culture and creative expressive environment may have to temper economic profit with other social values.

Even within the economically defined world, the unique characteristics of the network economy make clear that competition is not the only important way of relating to others for long-term economic survival. Cooperation and coordination are important as well. Incorporation of this knowledge into planning is to some degree just a shift in the way planners are thinking. For example, while in the short term it may be economically inefficient to let the children of illegal immigrants attend public school in the United States, the U.S. Supreme Court has realized that, considering the long-term costs to the community as a whole should those children not receive an education, it makes more sense economically to permit those children into the schools.

The problem of differences in access to information, including the ability to use it once it is acquired, is as important to economists as it is to society as a whole because research consistently shows that those differences are often due to differences in economic class. In the Internet environment, this is known as the problem of the "digital divide." With this in mind, policymakers struggle to ensure that access to the Internet is equal within and across communities. The problem is, of course, not unique to the Internet environment. Before there was any such thing as a digital divide, sociologists were studying the effects of the "knowledge gap" as it played out between the poor and the rich, the rural and the urban, the uneducated and the educated, the female and the male, and the black and the white.


The economics of information is a subfield of the general field of economics. It has risen in importance because of the shift to an information economy that is best described as a network economy. Economists are still learning how to adapt economic theory to apply to the new information environment, which seems to operate differently from economic environments of the past. In particular, cooperation and coordination have joined competition as all-important strategies for long-term economic success. The goal of such success, however, must be combined with other important social, cultural, political, and ecological goals to determine just what types of information policy are most desirable.

See also:Copyright; Electronic Commerce; Ethics and Information; Information Industry; Information Society, Description of; Machlup, Fritz; Privacy and Encryption; Use of Information.


Antonelli, Cristiano, ed. (1992). The Economics of Information Networks. Amsterdam: Elsevier Science Publishers.

Babe, Robert E. (1996). Communication and the Transformation of Economics: Essays in Information, Public Policy, and Political Economy. Boulder, CO: West-view Press.

Boulding, Kenneth E. (1966). "The Economics of Knowledge and the Knowledge of Economics." American Economic Review 56(2):1-13.

Braman, Sandra. (1999). "The Information Economy:An Evolution of Approaches." In Information and Organization, eds. S. Macdonald and J. Nightingale. Amsterdam: Elsevier Science.

Coase, Ronald J. (1937). "The Nature of the Firm."Economica 4:386-405.

Lamberton, Donald M. (1994). "The Information Economy Revisited." In Information and Communication in Economics, ed. Robert E. Babe. Boston: Kluwer Academic.

Machlup, Fritz. (1979). "Uses, Value, and Benefits of Knowledge." Knowledge 1(1):62-81.

Mansell, Robin, and Wehn, Uta, eds. (1998). Knowledge Societies: Information Technology for Sustainable Development. Oxford, Eng.: Oxford University Press.

Marschak, Jacob. (1968). "Economics of Inquiring, Communicating, Deciding." American Economic Review 58(2):1-18.

Porat, Marc Uri. (1977). The Information Economy: Definition and Measurement. Washington, DC: Office of Telecommunications, U.S. Department of Commerce.

Scazzieri, Roberto. (1993). A Theory of Production: Tasks, Processes, and Technical Practices. Oxford, Eng.: Clarendon Press.

Shapiro, Carl, and Varian, Hal R. (1999). Information Rules: A Strategic Guide to the Network Economy. Cambridge, MA: Harvard Business School Press.

Sandra Braman

About this article

Economics of Information

Updated About content Print Article