Explain why the cost structure associated with many kinds of information goods and services might imply a market supplied by a small number of large firms. (At the same time, some Internet businesses such as grocery home deliveries have continually suffered steep losses regardless of scale. Explain why.) Could lower transaction costs in e-commerce ever make it easier for small suppliers to compete? As noted in Chapter 3, network exter- nalities are often an important aspect of demand for information goods and services. (The benefits to customers of using software, participating in elec- tronic markets, or using instant messaging increase with the number of other users.) How might network externalities affect firm operating strategies (pric- ing, output, and advertising) and firm size?1.

a. A senior manager argues that the chip division's main purpose is to serve the firm's final-product divisions. Accordingly, these serv ices should be offered free of charge; that is, the transfer price for chips should be P0.

Explain carefully what is wrong with this argument.

b. Suppose the chip division treats the copier division as it would an outside buyer and marks up the transfer price above marginal cost. Explain what is wrong with this strategy.