Privacy, Economics, and Price Discrimination on the Internet Andrew Odlyzko Digital Technology Center University of Minnesota odlyzko@umn.edu http://www.dtc.umn.edu/~odlyzko Abstract Why is privacy eroding? There is wide concern about political and social impact of the increasingly detailed data collection and processing about our activities. However, most of the developments that reduce privacy are coming from corporations, which care about money, not politics. The thesis of this talk is that what really motivates these enterprises (even though they often do not realize it clearly themselves) is the strong incentive to price discriminate. This incentive is the result of the economics of the Internet, with high fixed and extremely low marginal costs. It is the same incentive that has led to the airline yield management system, with a complex and constantly changing array of prices. It is also the same incentive that led railroads to invent a variety of price and quality differentiation schemes in the 19th century. Privacy intrusions serve to provide the information that allows sellers to determine buyers' willingness to pay as well as to prevent arbitrage. Modern technology is thus both increasing the incentives to price discriminate and providing better means to do so. Contrary to a frequently made assumption, rice discrimination does not mean there is a monopoly or "market power." There are many examples, from telephones a century ago to airlines in recent years, which show that often, increased competition leads to increases in price discrimination. Economically, price discrimination is usually regarded as desirable, since it increases the efficiency of the economy. That is why it is often promoted by governments, either through explicit mandates or through indirect means. On the other hand, price discrimination often arouses strong opposition from the public. There are various findings in behavioral economics that help explain this opposition in principle. However, as is often the case, there is a question of what laboratory experiments might mean in practice. Thus it may be very illuminating to observe what happened when price discrimination was practiced in a very intrusive and extensive fashion. The example of 19th century railroads in the US and UK shows that their discriminatory practices were the main irritant that motivated the protest movements that led to government regulation. This suggests that overt differential pricing will continue to be resisted. There is no easy resolution to the conflict between sellers' incentives to price discriminate and buyers' resistance to such measures. The continuing tension between these two factors will have important consequences for the nature of the economy. It will also determine which technologies will be adopted widely. Governments will likely play a role in controlling pricing, although their roles will probably be ambiguous. Sellers are likely to rely on bundling, since that allows them to extract more consumer surplus and also to conceal the extent of price discrimination. Micropayments and auctions are likely to play a smaller role than is often expected. In general, because of the strong conflicting influences, privacy is likely to prove an intractable problem that will be prominent on the the public agenda for the foreseeable future.