Economics and Law 2009–10
Principal lecturer: Prof Ross Anderson Taken by: Part IB Syllabus
Past exam questions
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.
Game theory
We use game theory as a natural entry point into economics for the
computer scientist. Game theory deals with such fundamental issues as
whether people cooperate or fight to achieve their goals.
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.
At the level of routine economic analysis, 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? Given the small number of firms in the typical
IT market sector, understanding such issues is important for the
working computer professional.
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 initiated regular
tournaments of interated prisoner's dilemma which contributed to the
development of genetic programming ideas. The 20th anniversary
competition was won by
computer scientists from Southampton.)
Classical economics
I will then spend about two lectures developing 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 became a controversial
topic: the consensus view of economists can be found
in Steven Suranovic's
notes. The forced liberalisation of India's trade in 1991 provides
some useful
data on the value of free trade.
However the topic that excites most people, given the severe economic
downturn over the last year, is the business cycle. Progress over the
last three centuries has involved a pattern od several years' growth
followed by a year or more of recession. In order to understand this,
and assess its effects on our industry, we have to study some
macroeconomics. This year for the first time I'll have about half a
lecture on macro. A survey of the effects of credit crunches
historically has been written
by Reinhart
and Rogoff; a classic text from 1936 is Keynes' General
Theory of Employment, Interest and Money. The one economist to
have correctly predicted the credit crunch is Nouriel Roubini; his
macro lecture notes are here.
Information economics
Of enduring interest to computer scientists are some more modern
criticisms of the classical approach that fall within the realm of
microeconomics rather than macroeconomics.
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 (and
the antitrust
cases that successful tech companies often end up fighting). Monopoly
strategies include market 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? There's a good paper on Strategies for
Two-Sided Markets by Eisenmann, Parker and van Alstyne which
analyses who ends up subsiding whom, and why, in two-sided markets.
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.
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.)
Behavioural economics
Classical economics assumes rational actors, and yet we often see people acting
irrationally. The public misperception of risk is a particular problem: people
worry too much about terrorism, for example, and about child safety. There is
now a thriving field of "behavioral economics" at the boundary between
economics and psychology that seeks to explain systematically irrational
behaviour in terms of the perceptions and biases that we acquired in the course
of our evolutionary history.
Here are the slides for
the economics lectures.
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. (His notes
are here.)
As the syllabus puts it, these are: 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? A standard introductory text is
"Learning the Law" by Glanville Williams and ATH Smith.
The second talk, by Richard Clayton of FIPR, looks at more technology-specific
aspects of law and regulation. (His notes
are here.)
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; and 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. One of the best-regarded cyber-law courses is that
taught at Berkeley by Pam Samuelson (who deals mostly with US law issues); her
course notes
are here.
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.
The recent Pirate Bay case is just the latest in a long series of
skirmishes. A popular writer on the effects of IP law on innovation
is Larry Lessig; for further
analysis of the economic effects, see papers
by Scotchmer,
especially ``The Law and Economics of Reverse Engineering''. A paper
that has caused much controversy
is The
Effect of File Sharing on Record Sales: An Empirical Analysis by
Felix Oberholzer and Koleman Strumpf. This shows that file-sharing has
little effect on CD sales and may even help promote sales of the most
popular CDs. You might also be interested in a talk given at the
Computer Lab in 2002
by Richard
Stallman.
Even within Cambridge University, there was controversy at a plan by
the previous Vice-Chancellor to assume ownership of almost all
intellectual property rights generated by faculty and research
students. After we put up
some resistance
the current VC managed to grab our patent rights but left us,
for now, with our copyrights and 85% of the patent royalties.
So `economics and law' is a highly topical subject for people in our trade.
Supervisions, Books and Past Exam Questions
This course was created in 2002-3 by amalgamating and extending
some of the basic material in the part 2 E-commerce
and Business
studies courses. Exam questions since 2003 are here,
while some previous relevant Tripos questions 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 `Workouts in Intermediate Microeconomics'.
One word of warning: many part 1b students may never have studied a
humanties subject since GCSE. 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.
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