This paper describes the emerging field of Internet
Economics and some of the constituencies which are
shaping it. It defines the motivating factors for
looking at this area, reviews some recent research
results, and explores areas of overlapping interest.
The paper concludes with six recommendations for
further work.
different academic disciplines which have done work
related to Internet economics: technology, economics,
and policy. Each of these areas has important
contributions to make to the field but there has been
little consensus across disciplines (or even within
disciplines) on which direction to take. Figure 1
shows a Venn diagram which tries to characterize the
constituencies' current motivation to look at Internet
economics

Bailey, Joseph P.

McKnight, Lee

DSpace@MIT

Internet Economics Proc. INET '95 J. Bailey and L. McKnightInternet Economics:  What Happens When Constituencies CollideJoseph P. Bailey <bailey@rpcp.mit.edu>Lee W. McKnight <mcknight@rpcp.mit.edu>AbstractThis paper describes the emerging field of InternetEconomics and some of the constituencies which areshaping it.  It defines the motivating factors forlooking at this area, reviews some recent researchresults, and explores areas of overlapping interest.The paper concludes with six recommendations forfurther work.1 IntroductionInternet economics is a growing area of concern tomembers of the technical, business, academic, anduser communities.  While new applications, newusers, and new connections have spurred on theInternet to become an important medium forcommunication, information dissemination, andelectronic commerce, the economic policies currentlyundergirding the Internet may be less extensible.This paper examines how the different constituencies'often conflicting and overlapping interests arebeginning to yield to a rough consensus.In particular, the different constituencies arebeginning to share the recognition that the growth ofthe Internet is explained by its economic feature ofpositive network externalities, its technicalcharacteristic of statistical sharing, and its policyobjective of interoperability.  This definition of thecritical features of the Internet as well as otherfindings discussed in this paper are partially a resultof the authors' work in organizing an InternetEconomics Workshop (hereinafter referred to as "theworkshop") sponsored by the National ScienceFoundation and Advanced Research Projects Agency[29].  The workshop was held in Cambridge, MA atMIT on March 9 & 10, 1995.12 MotivationThe paper first identifies and characterizes the                                         1. The workshop was partially funded by the NationalScience Foundation, grant #NCR-9509244, and theAdvanced Research Projects Agency, contract #N00174-93-C-0036.  Please consult the workshop home page(http://rpcp.mit.edu/Workshops/cfp.html) for workshopnotes and other  workshop information.different academic disciplines which have done workrelated to Internet economics:  technology, economics,and policy.  Each of these areas has importantcontributions to make to the field but there has beenlittle consensus across disciplines (or even withindisciplines) on which direction to take.  Figure 1shows a Venn diagram which tries to characterize theconstituencies' current motivation to look at Interneteconomics.Figure 1:  Constituencies' Objectives*Technology PolicyEconomicsFigure 1 suggests that these communities do not atpresent agree in their views on Internet Economics.The workshop tried to find the common ground ofthese constituencies which is denoted by the "*" inFigure 1.  First, we identify the "full circle" viewpointof each of these constituencies.2.1 TechnicalTraditionally, the technical community hasn'tconcerned itself with the economic issues of theInternet.  The current version of Internet Protocolversion 4 (IPv4) offers users a best-effort service andit hasn't been necessary to ration a resource.Agreements between Internet Service Providers (ISPs)state that they intend to process traffic as quickly aspossible usually on a first-come-first-serve basis.  TheInternet "cloud" is an inherently statistically sharedresource of best-effort service.When the shared resources of the Internet becomescongested, users experience additional latency ordelay.  Users have adapted their behavior tocircumvent this latency by using the Internet duringInternet Economics Proc. INET '95 J. Bailey and L. McKnight2"off peak" hours for reduced latency.  The possibilityof not experiencing delays has traditionally beensolved by technical solutions such as a priorityqueuing method for certain interactive applications(e.g. telnet).2Statistical sharing of common facilities hasallowed the infrastructure to grow quickly androbustly.  Congestion problems experienced in somelinks were solved by increasing the bandwidthbetween these links.  This method of "over-provisioning" has worked well in the past but may notbe sufficient to improve the quality of service withmore recent technical developments – namely theintroduction of a new version of the Internet protocol.Internet Protocol version 6 (IPv6) promises tooffer multiple qualities of service beyond the currentbest-effort service.  If these services are not priceddifferently, it is possible there may not be enough ofthe shared resource to service each request.  Methodsfor rationing or pricing this service are now beingconsidered by engineers – a possibility that has beenconsidered by economists for quite some time.2.2 Economics and the InternetPerhaps two of the most commonly heldmisconceptions about the Internet involve itseconomics.  The first is that it is paid for by thegovernment when, in fact, in 1994 NSF paid for lessthan 10% of the Internet cloud.  The second is that theInternet is free.  MacKie-Mason and Varian detail thefrequently asked questions concerning the economicsof the Internet [20] and the economics for theinfrastructure [23].  We note further that for mostusers, the cost of local area networks and computersfar exceeds the costs which can be ascribedexclusively to Internet connectivity.  Below, we willbriefly analyze the economics of the Internet toprovide context for the remainder of the paper as wasexplored during the workshop.A common good, as defined by economists, is "[a]resource, such as air and water, to which anyone hasfree access."3  Economic theory suggests that theInternet can also be included as a common good sincethe "cloud" is common to all Internet users.Therefore, the Internet, like the environment, may beprone to abusive behavior by one of its users leadingto a degradation in that resource.  This has beencharacterized as a "tragedy of the commons" by                                         2. The NSFnet experienced such congestion over its56kb/s backbone in 1986 that it did just this.3. Pyndyck and Rubinfeld, (1995) Microeconomics,Prentice-Hall, p.670.Garrett Hardin [16].Economists have questioned the current practice ofusers experiencing latency when the Internet iscongested suggesting that some users may pay more tocircumvent congestion.The economic community feels that the pricingstructure of the Internet is sub-optimal.  As thedisparity between heavy users and lighter users of theInternet widen, more equitable and efficient pricingmechanisms will have to be created to enable self-sustaining growth of the Internet.  For a better pricingstructure, one that is more economically optimal, wecould imagine a system where the price equals themarginal cost.  However, costs in an IP network aretotally fixed except for some kind of congestion cost.All of the cost associated with people, electronics,leased lines, etc. have been paid for already and areseen as fixed costs.  The congestion cost means thatw en a user on the Internet sends or receives data,they are using bandwidth that could otherwise be usedby other users of the network.  It has been argued thatusage based pricing that reflects this congestion costwould be a more equitable pricing policy [22].Although this view is disputed across disciplines,some argue that it is only a matter of time before flat-fee pricing mechanisms fail as an expected Internetcrunch approaches and congestion costs increase.Since not all applications demand the same kind ofservice out of the Internet, it may be necessary toprioritize data traffic for lower levels of latency. Inparticular, video and voice traffic may need a higherlevel of service when Internet congestion is high.New services are being addressed by the engineeringcommunity (through ATM, IPv6, etc.) and mayrequire appropriate pricing mechanisms to emergewith these new services.On the other hand, there is a powerful economicincentive to cooperate induced by the significantpositive network externalities associated with beingon the Internet.  Cooperation through statisticalsharing  benefits each individual Internet user and hasbeen sufficient motivation to date to avoid the worstcase abuses which one could imagine.The challenge then is not only to develop effectiveInternet pricing mechanisms, but to do so withoutlosi  the benefits of interoperability and positiven twork externalities currently gained through theInternet's reliance on statistical sharing.  Achievingeconomic efficiency without inciting users to abandonthe Internet's technical approach of statistical sharing,and hence without abandoning the Internet as such, isthe challenge policy makers, businesses, and thepublic must now face.Internet Economics Proc. INET '95 J. Bailey and L. McKnight32.3 PolicyThe U.S. Government's role in the development ofthe Internet has changed with the NSFn t transitionplan, but continues to be an important role.  Evenwith the privatization of the federally-investedInternet backbone, the NSFnet, there are otherfederally-invested internets (ESnet, NSI, etc.).As an investor and large user of the Internet, theU.S. Government is very concerned with the self-sustaining economic growth of the Internet.  Themission agencies, such as NASA and the Departmentof Energy, operate their own wide area IP networkwhich interconnects with the Internet.  Therefore, thegovernment continues to be conscientious of how itinvests in them.  One of the main documents thatoutlines this guidance is the Office of Managementand Budgets (OMB) Circular A-130, Management ofFederal Information Resources.  This circular outlineshow federal agencies should coordinate their efforts sothat they may provide Internet services in a costeffective manner.Specifically, the government is interested in how itallocates and recovers costs for Internet services.OMB Circular A-130 states that the costs for theseinformation services should be accounted for so thatthere will be an equitable sharing of the costs toprovide these network services.  However, A-130changed in July of 1994 from its original 1985 formin the area of cost accounting and recovery for federalnetworks [28].  While the old circular was very directabout how to account and recover for costs, the newcircular is more general.  This change was a result ofthe difficulty of implementing the recommendationsfrom the original circular for shared data networkssuch as the IP networks federal agencies have.  Otherusers of IP networks have had similar difficulties indeveloping accounting and cost recovery systems forIP networks which were considered fair by users.The Department of Defense (DoD) decided toimplement a usage based cost recovery and pricingscheme for its inter-agency Internet called the DefenseData Network, the DDN [5], to implement thedirective of OMB Circular A-130.  The idea was tocharge each of the branches of the military for theirusage of the network to recover the costs.  However, itbecame apparent to the different DDN users that itwas difficult to budget money for networks sinceusage varied greatly from month-to-month. Instead ofencouraging people to use DDN for their networkingneeds, the different branches of the US militarydeveloped their own IP networks which they paid forin the more traditional flat-fee model.The Federal Networking Council and its AdvisoryCommittee, which facilitate information exchangeand action items for federal IP networks, have beeninvolved with the issue of cost accounting andrecovery.3 DefinitionsThroughout the aforementioned workshop, wefound it difficult for the different constituencies toagree on the definitions surrounding InternetEconomics.  For example, participants couldn't agreewhether or not the current Internet was characterizedby a "usage-based" pricing system.  It was argued thatpeople buy leased lines based upon expected usagethereby leasing a higher bandwidth, more expensivetrunk and, therefore, pay on a usage-based model.  Wedo not expect the struggles over the definition ofusage-based pricing to be resolved soon.  Instead, weuse the following definitions to characterize proposalsto price the Internet.1.  Flat-rate pricing:  Currently, most Internetusers pay a fee to connect while they are not billed foreach bit sent.  For example, a user may pay for a T1link regardless of how many bits they receive or send.2.  Usage-sensitive pricing:  Users pay a portion oftheir Internet bill for a connection (this price could bezer , but rarely is) and a portion for each bit sentand/or received.  The marginal monetary cost ofsending or receiving another bit is non-zero duringsome time period.  It is possible, for example, to haveusage-sensitive pricing during peak hours and flat-rat  during off-peak but we define the overall systemas being usage-sensitive pricing.3.  Transaction-based pricing:  Like usage-sensitive pricing, the marginal monetary cost ofsending and/or receiving another bit is non-zero.However, the prices are determined by thecharacteristics of the transaction and not by thenumber of bits.While we realize that these definitions may bedifferent for different constituencies, these definitionsare roughly agreed upon and necessary to discuss theresearch done in this area.4 Internet Pricing ResearchPricing policies associated with Interneteconomics include pricing for congestion control andinterconnection.  Many of the assumptions underlyingthe application-specific pricing policies intelecommunications, such as for telephony, aredifficult and costly to implement for the Internet.Furthermore, the Internet culture and economics are

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