Question

Do some research on a topic known to economists as the 'friction-free' or ‘low-friction’ economy. Early writers on this topic foresaw many of the seismic shifts that have occurred in the market place over the past one to two decades.  Some of these early writings on ‘friction’ discussed many of the business tools we now think of as either commonplace or even obsolete.  It is sometimes hard to imagine that businesses once embraced overnight mail, inexpensive fax machines, and email as being as monumental as we now think of business web sites, smart phone apps, Facebook, business portals (such as Amazon), and Google. The business tools becoming available may have been different, but the impacts on business strategies were dramatic. Once you have done your research, tell your classmates what you found, where you found it, and who the authors of the material are.

Next, tie the idea of a friction-free or low-friction economy to the concepts of demand and supply (Chapter 2), and demand elasticity (Chapter 3), two major topics in Managerial Economics. Some ideas that might be debated include, but are not limited to:

What is the connection or correlation between the amount of 'friction' in an economy and demand and supply? Does a relationship even exist? How can we quantify the relationship?

As friction in an economy decreases or increases, how is the demand for a firm's product or service impacted (does anyone remember when a traveler contacted a travel agent instead of Kayak for an airplane ticket, and the ticket was printed and presented to board a flight?)? Does it increase? Does it decrease? How can we measure the impact? How does the elasticity of demand for a firm's products change, if it does change? Are all firms impacted the same? Why or why not?

Is there an integral connection between friction in an economy and elasticity of demand? Why do you believe there is, or why do you believe there is not? If there is a connection, what is it? Can we measure or specify the relationship? If yes, how do we do so?

Answer 1

Friction-free economy refers to the idea that factors that stop and an economy from looking like the perfectly competive economy, where firms face perfect competition and are price takes, are eliminated or reduced. As the economy becomes low-friction, firms' competiton more and more resembles perfect or monoplistic competition (firms selling same or similar products competing with each other). Thus, friction factors like distance, consumer loyalty, barriers to entry in a market, availability of capital, lack of information, problems in starting and competing with incumbent firms, problems in finding, hiring and firing needed staff, etc. no longer hold back firms from competing with each other. In such an economy firms often at great distances from each others compete to provide valuable servies to customers. Firms that can not differentiate from their competition see a fall in their revenues and profits, and eventually have to close. Such an economy will have less middlemen and a more direct contact between the producer and the consumer. There will be most custom-made products available at low prices.

Friction-free economy was discussed by Bill Gates in his book in the mid-1990s, The Road Ahead, according to an article by on the topic by John Case in 1 June issue of Inc. magazine. An article by Mitch Ratcliffe for written Rational Rants on Jan. 2 2007 was found on ZDNet .com website. An blog article written on May 11 by Jon Gelberg on Oracle.com website on modern finance also discusses the topic. An LA Times article on 11 January 1996 by Gary Chapman critically discusses the topic --- some of the futuristic ideasmentioned in the article, like direct TV program streaming out of schedule by TV companies, direct selling and decline of video stores, have come true.

For a local customer friction less economy will increase supply options and for a local supplier it will increase potential customers. Thus, both supply and demand in local markerts is likely to go up as the economy becomes more friction-free or low-friction, and as local markets get integrated. It will also help inventories and markets clear more easily by better matching of demand and supply. However, the economy will become more competitve becase distant suppliers are able to fullfil demand. The impact on a firm demand can be measured by looking at increases in revenues from newer markets, and decreases in revenues from traditional markets or sales channels, and from newer activities and products.

As firms face more competition and are better integrated in the larger market, elasticity of demand for their products is likely to increase; that is, demand for their products becomes more sensitive to price due to increased competition. Firms that have specialized products with less close substitutes, better customer loyalty, better brand recongnition and brand loyalty are less likely to see an increase in price elasticty of demand for their products, becasue customers will be less sensitive to price changes in their products, particularly when their prices are higher than competiton. Changes in demand elasticity could be measured by designing experiments on online markets, or by estimating demand funtions and calculating elasticities from demand functions. This can be done by modelling demand and price data for the products that a firm is selling, in particular by regressing varying demand on varying price. This data is avalable from industry research firms, or can be collected as part of experiment on online markets (often done by large firms with sophisticated economics and marketing teams).