CHAPTER 16
The Knowledge Economy
CHAPTER SUMMARY AND TEACHING OBJECTIVES
This is the knowledge economy. The production and dissemination of knowledge is very different from
the production and dissemination of physical products. In fact, knowledge can be separated from
physical products. Here, goods can be produced a nearly zero marginal costs and networks exhibit large
externalities. It is increasingly more likely that students will be employed in knowledge firms.
They need to be made aware of this new world and what it means for management and incentives.
IMPORTANT TERMS
Intellectual Property Rights private property rights associated with knowledge
Increasing returns as additional workers are added to production, each worker adds increasing
amounts of output
TOPICS AND TEACHING SUGGESTIONS
1. Everything Has Changed
2. Increasing Returns and Networks
3. Internal Organization and Knowledge
In the knowledge economy, firms are no longer needed in a traditional sense. The cost of
74 Chapter 16: The Knowledge Economy
ANSWERS TO EXERCISES
1. If the downsizing trend of the late 1980s and early 1990s was due to technological change,
what should it mean for individual firm costs? If the downsizing trend was a mistake—firms
cutting employees and increasing productivity in the short term only to suffer long-term
reductions in productivity—what should it mean for individual firm costs?
2. Several cities are associated with specific industries: Akron with tires, Sunnyvale with computer
chips, Orlando with tourism, and Hollywood with movies. Why do such centers emerge?
3. Two networks are vying for dominance in the HDTV network, the United States and Europe.
It has been said that the winner is likely to be determined by economies of scale in
manufacturing televisions. Explain.
4. Amazon.com was the first mover in online book sales. It patented the one-click purchasing
system. Barnes and Noble was a later entrant with BN.com. Is this a battle with a “winner–
takes-all” outcome? Why or why not?
5. In early 1998, S3 was a small microchip-design firm with a big problem. The company knew
that Intel’s patent wall would eventually stall its high-performance graphic-microchip business.
S3 hatched a plan to fix the problem. It outbid Intel to acquire the patents of bankrupt microchip
maker Exponential Technologies. In doing so, S3 acquired a patent that predated Intel’s.
Explain why S3 spent $10 million to purchase a bankrupt firm. What is the implication for the
dominance of Intel?
6. In 1994, the $3.5 billion Avery Dennison Corporation developed a new film for use in product
labeling. The film unit won a contract to provide the labels for Procter & Gamble shampoo
bottles and appeared to have huge growth potential. But an analysis of patent activity indicated
that Dow Chemical was beginning to move into this business. Should Avery commit the huge
resources needed to exploit the market opportunity for the film unit?
7. Consider the following payoffs in a situation where the two firms have to choose simultaneously.
Firm B
Strategy
Yes
No
Yes
Firm A: $30
Firm A: $20
Firm A
Firm B: $10
Firm B: $15
No
Firm A: $20
Firm A: $2
Firm B: $15
Firm B: $4
a. How much would Firm A pay to go first?
b. How much would Firm B pay to go first?
c. Can you set up the payoff so that there is no first mover advantage?
8. How is the competition between Blu-ray and HD similar to the competition between
VHS and Beta?
9. Explain why an organizational structures other than hierarchy might make sense in the
knowledge economy. Can you justify a hierarchical organization?
10. What are intellectual property rights? How are they different from property rights to physical
assets? Why has digitization been a hazard to intellectual property rights?
11. How would you encourage innovation when whatever is invented or created is expensive to
invent or create and has a very low cost of copying and distribution?
12. Why do economists tend to disagree with protectionist measures that interfere with trade and
13. What does it mean to say that information can be separated from its physical product?
What does this imply for pricing the information?
14. Why are so many digital items given away for free?
15. Haven’t there always been “knowledge” workers, people who do more than what a robot
could do? Why then is such a big deal made of the “knowledge economy” and the
“knowledge worker” in recent years?
16. What leads to a patent race? Is such a race productive or unproductive? Explain.
17. “The beauty of markets is that, over time, they tend to ensure that both people and money end
up employed in the highest-value enterprises. In corporations, decisions about allocating
resources are made by people with a vested interest in the status quo.” Alan Murray, WSJ,
August 21, 2010, Weekend. Evaluate this statement. Is it true? Explain.
18. It is often said that in today’s world, gale-like market forces—rapid globalization,
accelerating innovation, relentless competition—have intensified what economist Joseph
Schumpeter called the forces of “creative destruction” so that even the best-managed
companies aren’t protected from this destructive clash between whirlwind change and
corporate inertia. What does this mean? Would you agree that even the best-managed
companies are not protected?
19. British economist Ronald Coase laid out the basic logic of the managed corporation in his
1937 work, “The Nature of the Firm.” He argued corporations were necessary because of
what he called “transaction costs.” It was simply too complicated and too costly to search for
and find the right worker at the right moment for any given task, or to search for supplies,
or to renegotiate prices, police performance and protect trade secrets in an open marketplace.
The corporation might not be as good at allocating labor and capital as the marketplace;
it made up for those weaknesses by reducing transaction costs. What implications does
Wikipedia have for this view of the firm?
20. According to some management gurus, mechanisms will have to be created for harnessing the
wisdom of crowds. Feedback loops will need to be built that allow products and services to
constantly evolve in response to new information. Change, innovation, and adaptability all have to
become orders of the day. Explain how markets inside the firm might be the solution to these
challenges.