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Internet Market Efficiency

Kris Ananthakrishnan
Friday, January 31, 2003
Kris Ananthakrishnan
E-COMMERCE PUNDITS HAVE BEEN KNOWN TO claim that ‘if there exists a “perfect” market, it is the Internet’—where perfect competition and frictionless commerce combine to squeeze out all market inefficiencies. Is this claim really true? Are the prices charged on the Internet generally lower? Are consumers more sensitive to small price changes on the Internet? Do retailers adjust the prices more finely or more frequently on the Internet? Is there a smaller spread between the highest and the lowest prices on the Internet? The answers to these questions may surprise you, or at the very least, get you thinking differently the next time you go surfing for the best price for that CD that you have been meaning to buy.

Market Efficiency
Market efficiency is a term that needs some explanation here.
Fifteen years ago, when Cyberabad was just a twinkle in Chandrababu Naidu's eyes, farmers in Andhra Pradesh gathered every night around the community TV set, eagerly awaiting the eight o’clock “Farmers News” program. The highlight was a segment where retail prices of rice, grains, and a host of other commodities were announced for about a dozen local markets. Armed with this information, they would head to the wholesale market the next day. Wholesalers, who until then lowballed the farmers with ridiculously low prices, now faced a new reality.

What does this have anything to do with Internet market efficiency? Plenty, as it turns out. It’s all about information and its availability. Intermediaries (like the wholesalers) thrive on information imbalance. Take that imbalance away, and now you have a much leaner supply chain. Throw in a good measure of market transparency into this mix, and suddenly information asymmetry vanishes. As the asymmetry of information reduces, there would be lesser and lesser need for middlemen, and the market could potentially progress towards an ideal trading environment that imposes little cost or restraints on transactions! Isn't this what the information revolution is all about? The Internet as a medium of information exchange has definitely had an effect on the dynamics of trade. The question is, whether the entire business landscape, currently dominated by infomediaries, be ever dramatically altered into a 'frictionless' medium. Maybe in the future, but don't hold your breath, say researchers at M.I.T.'s Sloan School of Business.

Dimensions of Market Efficiency
To get a clear picture of efficiency of electronic markets, M.D.Smith, J.Bailey, and E.Brynjolfsson, professors at Sloan suggested four distinct parameters—Price level, Menu cost, Price dispersion, and Price elasticity. Each of these parameters would essentially provide efficiency readings for a particular dimension of the market. Juxtapose these with corresponding data observed in the conventional market, and a picture would begin to emerge.

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