Economics and Law 2002-03
Taught by: Dr Ross
Anderson, Dr Robert Evans,
Mr Nicholas Bohm and Mr Richard Clayton.
Taken by: Part IB
Syllabus
Introduction
At one level, this course provides a bridge between the professional
practice and ethics course in part 1a and the courses in business and
e-commerce in part 2. But that is not all.
Economic arguments are starting to appear in a surprising number of
areas of computer science. Economics deals with mechanisms whereby
global equilibria emerge from the behaviour of large numbers of agents
who optimise their utility locally. Economic arguments and techniques
are starting to be used by computer scientists to tackle problems from
network congestion, through resource allocation in distributed
operating systems, to security. As systems become ever larger, these
techniques are likely to become more important. (I got roped into
teaching this course because of my interest in the interaction between
economics and
information security.)
Useful though economic arguments and explanations may be, however,
there are many reasons why market mechanisms may fail, or yield an
equilibrium that is far from the social optimum. Law deals with rules
developed to remedy this. As the Internet has changed from a research
tool to a public utility over the past ten years, legal questions have
become increasingly important to computer scientists.
One word of warning, though. Many part 1b students may never have
studied a humanties subject above the GCSE level. It is a different
task from learning a programming language; it is not sufficient to
acquire proficiency at a small core of manipulative techniques, and
figure out the rest when needed. Breadth matters. You should spend at
least half of the study time you allocate to this subject on general
reading. There are many introductory texts on economics and on law;
your college library is probably a good place to start.
Classical economics
The first two lectures will look at the classical view of economics:
that under certain assumptions, markets provide an optimal way of
allocating resources. This view had its roots in Adam Smith's Wealth of
Nations and was further developed by writers such as Ricardo
and Jevons
to provide an explanation of the forces driving the industrial
revolution. We'll explore concepts such as comparative advantage,
marginal utility, opportunity cost and exchange, so that you get at
least a rough idea of what's `under the hood'.
We will then look briefly at a number of the ways in which classical
economic models fail, including the criticisms of Keynes and the
fact that efficiency, welfare and justice do not always coincide.
There is a huge literature on basic economics. Cambridge economics
students cut their teeth on Varian's textbook, `Intermediate
Microeconomics', of which your college library should have many
copies. You might look at chapters 1-6 and 14-16 to begin with. For an
entirely different perspective, try JK Galbraith's `History of
Economics'. A very convenient online reference is the History of Economic Thought
website. With the collapse of the Soviet Union and the growth of
anti-globalisation protests, trade is perhaps the most controversial
topic nowadays: the consensus view of economists is probably well
represented by Steven
Suranovic's notes.
Information economics
Of greater interest for computer scientists, however, are some more
modern criticisms of the classical approach that fall within the realm
of microeconomics rather than of macroeconomics or social theory.
Information goods and services markets tend to be characterised by
high fixed costs, low marginal costs and increasing returns to scale,
together with lock-in effects, all of which tend to lead to monopoly
or oligopoly. In many markets, there are also network effects: the
more people use a given service, the more value it is to each user.
So products may take a long time to reach critical mass, then take
off very rapidly (as happened with faxes in 1985-88 and email ten
years later). Network effects can reinforce a tendency to monopoly.
We will look at a number of other ways in which information goods and
services markets can deviate from the classical ideal. These include
asymmetric information, where one party to a contract knows more than
the other. For example, people applying for health insurance typically
know more about their health than the insurance company does, and this
leads to adverse selection effects whereby sick people buy more cover.
(Attitudes to risk in general are well known to be perverse; see John
Adams on Cars,
Cholera and Cows.)
The strategies used by monopolies to maximise their revenue are
important, both as a practical foundation for later work on e-commerce
and as a theoretical underpinning for understanding regulation. These
include marget segmentation, price differentiation and bundling. Why,
for example, does Microsoft prefer to sell Office as a single product
rather than as separate word processor, spreadsheet and other
programs?
By far the best book on this is Shapiro and Varian's `Information
Rules'. Varian's textbook also has some useful material, especially in
chapters 32-36. As for online resources, there are many: the Information
Economy page at Berkeley is a reasonable place to start.
Game theory
Game theory provides useful tools for understanding monopoly and
oligopoly behaviour. For example, suppose that it costs $250 to fly a
passenger from Boston to London and back, and only two airlines
comnpete on the route. How will they set prices? Will they collude and
charge $500 each, making a healthy profit, or will they compete for
market share and charge $300 or even $255? What sort of strategies are
available, and what sort of equilibria might emerge?
One of the classic puzzles in game theory is the Prisoner's
dilemma. Two crooks are arrested and questioned separately about a
robbery. The police tell each of them that if he confesses, he will go
free while his partner will get 10 years for the robbery. If he keeps
quiet and his partner confesses, it will be the other way round. If
both confess, they will get five years; while if neither confesses,
they will get a year each for possessing a firearm. Here, the optimal
strategy from the prisoners' collective viewpoint is for both to keep
quiet, but if they cannot both trust the other then the optimal
strategy for each individual is to confess.
This is typical of many problems encountered in real life. Resolving
them is easier where the games are not isolated, but are part of a
series. Then one might, for example, have a strategy of tit for
tat - if you cooperate with me this round, I'll return the favour
next time; but if you stab me in the back, I'll retaliate. There has
been a lot of study of such strategies; they are important not just in
economics, but also in fields such as evolutionary biology where the
evolution of strategies is believed to be the foundation for much
social behaviour in animals.
There are many books and web pages, such as Game Theory .net and the Stanford
Encyclopaedia of Philosphy. (Of particular interest to computer
scientists is the work of Robert Axelrod, one of
the pioneers of the evolution of cooperation, who ran regular
tournaments of interated prisoner's dilemma which contributed to the
development of genetic programming ideas.)
Auction theory
A lot of current work in auction theory spills over between economics
and computer science. Auctions have been around since at least the
times of ancient Greece; they have long been the traditional way of
selling art, livestock and much else. A lot of money was invested
during the dotcom boom on the premise that technology would so lower
the transaction costs associated with auctions that they would become
the dominat means of doing business in many sectors. Ebay grew from
nothing to blue-chip status in a few years; and the UK government made
billions from auctioning off spectrum for third-generation mobile
phones.
A surprising number of things can go wrong with auctions. The British
government's success was not replicated everywhere else; in a number
of countries, phone companies managed to rig the auctions and get
bandwidth cheaply. Often this didn't require any overt criminal
behaviour; the rules of the auctions were such that players could
signal to each other, during the bidding process, which blocks they
were interested in. The resulting tacit collusion meant that the
taxpayers in many places got much less than expected. (The UK
government's adviser, Paul
Klemperer, has some interesting papers on what people did wrong -
see especially `What Really
Matters in Auction Design' for the practicalities. For a proof of
the Revenue Equivalence Theorem, see his Guide to
the Literature, and for its applications see Why
Every Economist Should Learn Some Auction Theory.)
At the theoretical end of things, there has been a huge surge of
interest among computer science researchers in the design of
combinatorial auctions. A combinatorial auction is one in which you
can bid for combinations of objects: `I'll give you $100 for lots 1
and 4 and 7, or I'll give you $80 for lots 3 and 4 and 7'. Finding an
optimal allocation in such an auction is not merely an NP-complete
problem, but is close to many engineering problems of practical
interest - such as finding a low-cost route across a network. (For
more detail and links, see the notes of a course
at Berkeley by Christos Papadimitriou.)
Introduction to law
There will be two talks on legal topics. The first, by Nicholas Bohm
of the Law Society's Electronic Law Committee, will cover the
basics. As the syllabus puts it: contract and tort; copyright and
patent; liabilities and remedies; competition law; choice of law and
jurisdiction. The gloss on that is: what do you have do do online in
order to incur liability, or to impose it on someone else; and where
can you be pursued, or pursue them, through the courts once you have
done so?
The second talk, by Richard Clayton of FIPR, looks at more specific
issues of law and regulation. There are a number of EU directives which
affect how you can do business on the net, covering subjects that range
from distance selling, electronic commerce, data protection and
electronic signatures to copyright; there are a number of particular
issues relating to their UK implementation. There are also some specific
UK laws, such as the Regulation of Investigatory Powers Act, that one
might have to watch out for.
Intellectual property
The course title `economics and law' also refers to the academic
discipline whose subject matter centres on copyright, patent, and
related topics such as database rights. This will be the topic of the
final lecture.
Intellectual property is increasingly seen as the foundation of
prosperity in the information age, but is increasingly controversial.
Powerful lobby groups, such as Hollywood and the music industry, have
pushed for increased legal protection in ways that have brought them
into conflict with the computer industry and with liberties groups.
See for example the talk given at the Computer Lab by Richard
Stallman this March. For an anlysis of the economic effects, see
papers by Scotchmer,
especially ``The Law and Economics of Reverse Engineering''.
Even within Cambridge University, there has been controversy at a plan
by the Vice Chancellor to assume ownership and control of all
intellectual property rights generated by faculty and research
students. In fact, one of the reasons why these lecture notes are so
short is that I have spent much of the past couple of months helping
organise resistance to these
plans; another is that if they go through, the copyright on lecture
notes like these will no longer be mine but the University's (so if I
ever incorporate them up into a book, I might have to share the
royalties). I may refer to work by Friedman
and Silberman on academic incentives; there is a lot more material
linked from here. The
best-regarded cyber-law course is that taught at Berkeley by Pam
Samuelson; the notes are here.
So `economics and law' is still a breaking story, and I hope to bring
the news from the trenches.
Supervisions
This course has been created by amalgamating and extending some of the
basic material in the part 2 E-commerce
and Business
studies courses. Some previous Tripos questions that are still
relevant are here, here, and here. In
addition to this, see the revision questions in Varian's textbook,
chapters 1-6, 14-17, 24-25, 27-28 and 32-36, and the problems in its
companion volume of `Workouts in Intermediate Microeconomics'.
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