Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 16

Does Buying Things on the Internet Improve Welfare?
Technical innovations together with significant network externalities have sharply reduced the transactions costs associated with conducting business over the Internet. These innovations offer the promise of transforming the way selling is done in many industries.
The Gains from Internet Trade
Figure 1 illustrates the nature of the gains from reduced transactions costs of Internet trading. The demand and supply curves in the figure represent consumers' and firms' behavior vis-à-vis any good that might be bought and sold over the Internet. Prior to the decline in Internet costs, per-unit transactions costs exceeded P 2 - P 1. Hence, no trading took place; buyers and sellers preferred traditional retail outlets. A fall in these costs increased Internet business. Assuming that the perunit cost of making transactions fell to zero, the market would show a large increase in Internet trading, settling at the competitive equilibrium, P* , Q*. This new equilibrium promises substantial increases in both consumer and producer surplus.
The Growth of E-Commerce
Although Internet retailing is relatively new, its growth has been remarkable. In 2013 e-commerce amounted to over $250 billion-nearly six percent of all retail sales. The most important early inroads by Internet sales were in travel-related goods (airline and resort reservations), online financial services, and some narrow categories of consumer goods (for example, books sold by Amazon.com). These are goods for which Internet trading represented some of the largest reductions in transactions costs relative to traditional outlets. More recently, e-commerce has made inroads into many other areas as traditional retailers such as Williams-Sonoma or Home Depot make increasingly large fractions of their sales over the Web, and Amazon has vastly expanded what the firm offers.
The Value Added by Internet Retailers
One question raised by the growth of Internet selling is whether there will remain a separate role for retailers over the long term. If the Internet allows producers to reach customers directly, why would any role for retailing "middlemen" remain? The answer to this query lies in the nature of services that e-retailers can provide. In general, the primary good that such retailers provide is information. For example, Internet automobile sites (such as Edmonds.com or Autobytel.com) not only provide comparative information about the features of various models, but can also point to the dealer that gives the
best price. Internet travel services can search for the lowest fare or for the most convenient departure. Many retailing sites make use of customer profiles to suggest items they might like to buy. For example, Amazon.com uses a customer's past book purchases to suggest potential new ones. At LandsEnd.com you can even "try on" clothes. Hence, it appears that Internet retailing is evolving in ways that make the most use of the low cost of providing information to consumers.
How will the growth of Internet retailing affect traditional "bricks-and-mortar" retailers such as Wal-Mart or Sears? What special services can these retailers offer that the Internet cannot? Are people willing to pay for such services?