The Emerging Role of Electronic Markets

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I n t e r n e t

E c o n o m i c s

Internet-based electronic marketplaces leverage information technology to match buyers and sellers with increased effectiveness and lower transaction costs, leading to more efficient, “friction-free” markets.

The Emerging Role of

Electronic Marketplaces on the Internet
Markets play a central role in the economy, facilitating the

Yannis Bakos

exchange of information, goods, services, and payments. In the process, they create economic value for buyers, sellers, market

intermediaries, and for society at large. Recent years have seen a dramatic increase in the role of information technology in markets, both in traditional markets, and in the emergence of electronic marketplaces, such as the multitude of Internet-based online auctions. Functions of a Market Markets (electronic or otherwise) have three main functions, summarized in Table 1: matching buyers and sellers; facilitating the exchange of information, goods, services and payments associated with market transactions; and providing an institutional infrastructure, such as a legal and regulatory framework, that enables the efficient functioning of the market. In a modern economy, the first two functions are provided by intermediaries, while the institutional infrastructure is typically the province of governments. Internet-based electronic marketplaces leverage information technology to perform these functions with increased effectiveness and reduced transaction costs, resulting in more efficient, “friction-free” markets. Matching Buyers and Sellers. Markets “clear” by matching demand and supply. This process of matching buyers’ demand with sellers’ product offerings has three main components: determining Matching buyers and sellers • Determination of product offerings - Product features offered by sellers - Aggregation of different products • Search (of buyers for sellers and of sellers for buyers) - Price and product information - Matching seller offerings with buyer preferences • Price discovery - Process and outcome in determination of prices Facilitation of transactions • Logistics - Delivery of information, good, or service to buyer • Settlement - Transfer of payment to seller • Trust - Credit system, reputations, rating agencies like Consumer Reports and Better Business Bureaus Institutional infrastucture • Legal - Commercial code, contract law, dispute resolution, intellectual property protection • Regulatory - Rules and regulations, monitoring, enforcement Table 1. Functions of a market COMMUNICATIONS OF THE ACM August 1998/Vol. 41, No. 8

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Establishing a dialogue and a sense of community among customers can create value by enabling the sharing of experiences, problems and solutions, but also allows the collection of important information about individual consumers.

product offerings, search, and price discovery. The behavior of buyers, sellers, and intermediaries is motivated by their desire to maximize their private utility. When markets function well, this also leads to an efficient allocation of productive resources. Viewed this way, markets are the engine and steering system of our economy. Markets provide sellers with information about demand that allows them to employ economic inputs such as capital, technology and labor, and develop products with characteristics that match the needs of buyers. Sellers determine a schedule of product offerings that they expect will maximize their profits based on: • information about buyer demand; • the cost of inputs; • the available technology for production and distribution of the information, goods and services purchased by the buyers; and, • the transaction costs of administering production, distribution, and payment. Buyers select their purchases from the available product offerings after considering factors such as price and product characteristics. In obtaining and processing this information, buyers face search costs. These costs include the...
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