Effect of technological breakthroughs on electronic markets

Abstract

Electronic markets have profoundly affected competition and market structures. Many authors have argued that electronic markets can promote competition and increase allocational efficiency, primarily by reducing buyer and seller search costs. However, conventional competitive models do not explain several phenomena we actually observe in electronic markets. Consequently, a variety of researchers have introduced complications to the basic competitive search model, including asymmetric information, branding and product differentiation, network effects, and agency considerations in order to explain e-commerce behavior. However, most previous studies neglect the fact that such characteristics may reflect underlying market evolution processes. Depending upon the evolutionary pattern of a market, the behavior and performance of markets differ. In this paper, we construct a model to examine e-commerce in the framework of dynamic market evolution. Using a system of replicator dynamics, we split a market into two distinct parts and show that the competition within the two segments will follow different, though interrelated evolutionary patterns. We supply the conditions for the existence of a unique global stable equilibrium in this dynamical system. Our model suggests that exogenous increases in online customers triggered by technological breakthrough often play more important roles than price differentials in determining the evolutionary path of a market. By emphasizing the short term disequilibrium along the market evolution path, our study complements the competitive equilibrium view of electronic market.