Japan and the World Economy 21 (2009) 239247

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Japan and the World Economy

journal homepage: www.elsevier.com/locate/jwe

The impact of e-commerce: It always benets consumers,

but may reduce social welfare
Yuji Nakayama
School of Economics, Osaka Prefecture University, 1-1 Gakuen-cho, Naka-Ku, Sakai, Osaka 599-8531, Japan

A R T I C L E I N F O

A B S T R A C T

Article history:
Received 10 August 2007
Received in revised form 28 September 2008
Accepted 28 October 2008

This paper investigates the impact of e-commerce on social welfare using a linear city model. Our model
incorporates the diversity of consumers such that some can purchase the good via the Internet while
others cannot. Our main result is as follows. The appearance of e-commerce enhances retail competition
and always increases consumer surplus. However, total surplus does not necessarily improve. This is
because the equilibrium market division between conventional stores and e-commerce is not socially
optimal and efciency loss of distribution accrues if the population of Internet shoppers is small and/or
the cost of e-commerce is high. Our theoretical results indicate that the small e-commerce market share
in the Japanese and US economies may result in welfare loss.
2008 Elsevier B.V. All rights reserved.

JEL classication:
L13
Keywords:
e-Commerce
Linear city model
Oligopoly

1. Introduction
Since electronic commerce (e-commerce) via the Internet
appeared in the second half of the 1990s, it has grown at a rapid
speed. The Ministry of Economy, Trade and Industry (METI) reports
that, in METI (2008), Japanese market sales of business to
consumer e-commerce in 2007 was about 5.3 trillion yen, a 21.7
percent increase from 2006. It also reports that in 2007, the US
gure was about 205.6 billion dollars, a 17.6 percent increase from
the previous years gure.1 The percentage of e-commerce in total
sales is still small.2 However, growth in the e-commerce market is
enormous.
In general, an additional channel of trade benets consumers if
it reduces their transaction costs and provides the product at a
lower price than the existing channel. This phenomenon applies
exactly to e-commerce. Thus, it is often considered that ecommerce is welfare enhancing.3

1
These Japanese and US gures include, in addition to retail sales, not only
service markets sales such as hotel reservations via the Internet, but also charges for
digital content, fees for Internet banking, etc. When we consider only retail and
service sales, the Japanese gure was about 3.3 trillion yen, while the US gure was
131.6 billion dollars. The former (the latter) is 22.1 percent (17.9 percent) higher
than the previous years gure.
2
METI (2008) reported the e-commerce share of the retail and service market in
2007; it was 1.52 percent in Japan and 3.1 percent in the US.
3
See Brynjolfsson and Smith (2000) and Smith et al. (2000), for example.

0922-1425/$ see front matter 2008 Elsevier B.V. All rights reserved.
doi:10.1016/j.japwor.2008.10.001

In this paper, we show that the advent of e-commerce may not

increase social welfare in total, even if the above benets for
consumers exist. Specically, incorporating e-commerce into a
linear city model a la Hotelling (1929), we show that the
appearance of e-commerce lowers price, which raises consumer
surplus. However, we also show that there are cases where total
surplus decreases, after the start of e-commerce. In our oligopoly
model, this is because of an efciency loss of distribution arising in
the market division between conventional stores and an ecommerce site in equilibrium.4
Existing papers related to our model include Nishimura (1995),
Balasubramanian (1998), and Bouckaert (2000). Nishimura
(1995) incorporates competitive discount stores into a circular
city model a la Salop (1979) to analyze the competition between
neighborhood stores and discount stores, and shows that the
equilibrium share of discount stores is larger than the optimum.
Balasubramanian (1998) analyzes the competition between
conventional retailers and a direct marketer. The former corresponds to neighborhood stores, and the latter corresponds to
a discount store discussed in Nishimura (1995). However,

4
Baye and Morgan (2001) also consider the welfare implications of the Internet
on our economy. They point out that a new service on the Internet may reduce social
welfare. They show that introducing price information services for an homogeneous
product may have a negative impact on the economy when a rm offering this
service has monopoly power.

240

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

Balasubramanians (1998) model is different from Nishimuras

(1995); Balasubramanian (1998) assumes that a direct marketer is
a monopolist. He shows that the direct marketer, in order to lessen
the competition with conventional retailers, strategically does not
provide information about the goods he sells (i.e., does not send
catalogs) to some consumers. Bouckaert (2000) also analyzes the
competition between conventional retailers and direct marketers,
although he calls the former stores, and the latter mail order
businesses (MOB). His model is different from Balasubramanians
(1998) because it is a multistage game, which has a stage in which
a rm chooses whether it operates a store or an MOB. He shows
that in equilibrium only one rm runs an MOB with monopoly
power.
Our model is similar to those of Balasubramanian (1998) and
Bouckaert (2000) because we consider a monopoly e-commerce
retailer. However, while these two papers do not examine the
welfare implication of a new channel (direct marketer or MOB), we
explicitly do so, as in Nishimura (1995).5
A distinguishing feature of our model, which differs from
Nishimura (1995) and Bouckaert (2000), is the heterogeneity of
consumers: one (later we call young) has access to the Internet,
while the other (old) does not. This setting follows Balasubramanian (1998) where there exist consumers that cannot buy the
product from the direct marketer.6 We examine if there exists not
only an equilibrium where the demand of the young is shared
among all the retailers, but also an equilibrium where the
conventional retailers abandon it and all young consumers do
their shopping via the Internet channel. The latter equilibrium is
not investigated in Balasubramanian (1998).
The remainder of this paper is organized as follows. In Section 2,
we describe a basic model and characterize an equilibrium with
and without e-commerce. In Section 3, we extend the basic model
with e-commerce by incorporating the heterogeneity of consumers and examine an equilibrium of the extended model. In
Section 4, we examine the welfare implications of the equilibrium
of the extended model and present the main results. Concluding
remarks are given in Section 5. All proofs of lemmas and
propositions are in Appendix A.

Suppose that the price of C-retailer j ( j 6 i) satises pCj > v  c.

Then, the demand for C-retailer i is as follows:
8
v  pCi
>
>
<
if 2v  pCj c  pCi  v;
C
C
C
c
Di p i ; p j
c pCj  pCi
>
>
:
if pCj  c  pCi  2v  pCj c:
2c
(1)
Note that DCi has a kink at pCi 2v  pCj c.7 By setting pCi , CC
retailer i maximizes its prot, Pi pCi DCi , where its marginal cost
is assumed to be zero.
The next lemma shows the equilibrium price in this model:

Lemma 1. The Nash equilibrium price that each C-retailer sets in the
model without e-commerce is given as
8
3
>
>
>
c
if v > c;
>
>
2
<
(2)
pC v  c if c  v  3 c;
>
2
2
>
>
>
v
>
:
if v < c:
2
From this lemma, we know that, if v < c, then
DCi pC ; pC v=2c < 1=2. In this case, the two C-retailers markets
do not adjoin, and consumers located in the middle of the city have
no demand. In other cases, the market is covered and each
consumer has positive demand, although the kink in demand,
which causes the discontinuity of marginal revenue, yields
different equilibrium prices depending on whether v > 3=2c.
In the following, we assume that v is sufciently high to satisfy
Assumption 1. v > 3=2c.
Under this assumption, all the market is served by the Cretailers before e-commerce appears. This assumption simplies
the analysis while keeping the results we can obtain unchanged in
essence.
2.2. Model with e-commerce

2. Basic model
Consider a linear city of unit length 0; 1. Consumers are
uniformly distributed with unit density along this interval. Each
consumer buys at most one unit of a product, whose reservation
price is v. In the following, we use subscript  () to denote an
equilibrium value without (with) e-commerce.
2.1. Model without e-commerce
First, we consider the model where e-commerce does not exist.
There are two conventional retailers in the market. The two
conventional retailers (hereafter C-retailers 1 and 2) set up their
physical store on the linear market. For simplicity, we assume that
C-retailer 1 (C-retailer 2) builds its store on the left (right) end of
the market. They sell the same product. If a consumer buys the
product from C-retailer i located at a distance x from the consumer,
she incurs pCi cx where pCi is C-retailer is price and c > 0 is the
unit cost per distance.

5
Strictly speaking, we examine whether or not welfare increases after the
introduction of an e-commerce channel in equilibrium, while Nishimura (1995)
compares the welfare of an equilibrium with that of the optimum.
6
The diversity of consumers is also introduced by Coughlan and Soberman
(2005) for analyzing the competition between primary retailers and outlet stores.

Next, we describe the model with e-commerce. We assume that

a single electronic retailer (hereafter E-retailer) operates in the
e-commerce channel.8 Thus, there are the two C-retailers and one
E-retailer in the market. The E-retailer sells the same product as the
C-retailers do. The E-retailer does not have a store, but ships
products from its warehouse to consumers. If a consumer buys the
product from the E-retailer, she incurs pE e where pE and e are
the E-retailers price and a delivery charge, respectively.9 Because
consumers do not take care of pE and e independently, but they
care about the total cost, pE e, henceforth we denote p E pE e
and assume that the E-retailer chooses p E to maximize its prot.
Consider the demand for C-retailer i, given pCj and p E that
satisfy pCj < p E < pCj c and p E  v. Replacing v with p E in (1), we
obtain the demand for C-retailer i as follows:
7
If the consumer located at a distance x from C-retailer j is indifferent whether or
Substitute
not she buys the product from this retailer, then it holds that v pCj cx.
we obtain pCi 2v  pCj c.
x v  pCj =c into v pCi c1  x,
8
Bouckaert (2000) shows that there is one E-retailer (MOB in his analysis) in
equilibrium. We assume that the number is one, for simplicity.
9
The term e can be interpreted as utility loss because the products are not
physically examined before purchase. Chiang et al. (2003) and Aiura (2007) adopt
such an interpretation, although their models are different from ours. We can also
consider the situation in which the E-retailer sells an information product. In this
case, e can be interpreted as decreased utility of the information product (e.g.,
inferior sound quality of music via the Internet).

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

241

Fig. 1. Equilibrium of basic model with e-commerce.

8
>
p E  pCi
>
>
<
c
E
C
C
C
Di pi ; p j ; p
C
>
p

c  pCi
>
j
>
:
2c

if

2 p E  pCj c  pCi  p E ;

if

pCj  c  pCi  2 p E  pCj c:

(3)

Then, examine the demand for the E-retailer. This is the residual
obtained from subtracting the C-retailers demand from total
demand: DE 1  DC1 DC2 . Given that pC1 pC2 c=2 < v, it is
represented by
DE p E ; pC1 ; pC2
8
c pC1 pC2  2 p E
pC pC2 c
>
>
if max pC1 ; pC2  p E  1
;
>
<
c
2
!

E
E
C
C
>
p  p1 p  p2
>
>
;
if min pC1 ; pC2  p E  max pC1 ; pC2 :
: 1  max
c
c
(4)
Note that pC1 pC2 c=2 is the total cost of a consumer located
at x that satises pC1 cx pC2 c1  x.10 Furthermore, note that,
when min pC1 ; pC2  p E  max pC1 ; pC2 , the C-retailer that sets a
higher price than the other C-retailer obtains no demand.
The prots of C-retailer i and that of the E-retailer are

PCi pCi DCi

i 1; 2;

(5)

PE p E  wE eDE ;

(6)

respectively, where wE is the marginal cost of the E-retailer, and DCi

and DE are the demand for C-retailer i and that for the E-retailer: (3)
and (4). Hereafter we denote w
E wE e. In addition to
Assumption 1, we assume the following in this model:
Assumption 2. 0  w
E < v.
In the subsequent analysis, only the difference between the
marginal costs of the C-retailers and the E-retailer is important.
Thus, we maintain the assumption that the C-retailers marginal
cost is zero.
Next, we proceed to the maximization problem of the C- and Eretailers and derive an equilibrium. First, consider the C-retailers
problem. Note that, whether one C-retailer competes directly with
another C-retailer or with the E-retailer, asymmetric prices cannot
be possible in equilibrium because of the symmetry between them.
Thus, without loss of generality we can only consider an
equilibrium where each C-retailer sets the same price ( pCi pC
10
Solve this equation for x, then we obtain x c pC2  pC1 =2c. Substitute this
into pC1 cx or pC2 c1  x, then we have pC1 pC2 c=2.

for i 1; 2). Replacing v with p E in (2), we have each C-retailers

prot-maximizing price given p E as follows:
8
3
>
>
if p E > c;
>c
>
2
>
<
c
3
(7)
pC
if c  p E  c;
p E 
>
2
2
>
>
E
>
p

>
:
if 0  p E < c:
2
Next, consider the problem of the E-retailer. Assuming that
pCi pC for i 1; 2 and pC c=2 < v, we derive the prot
maximization price for the E-retailer. From (4) and (6), it is given
as follows:
8
c
C
>
>
if pC > w
E ;
>p
>
2
>
<
C
c
c
E
(8)
p E c p w
if w
E   pC  w
E ;
>
4
2
2
2
>
>
>
c
E
E
>
:w
if pC < w

 :
2
Let us examine the Nash equilibrium. If the pair of prices
pC ; p E satises both (7) and (8), then it is in a Nash equilibrium,
which is summarized as the following proposition:

Proposition 1. Suppose Assumption 1 and Assumption 2. The Nash

equilibrium prices of the model with e-commerce are given as
8
3
>
>
cw
c; w
if
E < v;
E
>
>
>
2
>

>
>
<
1
3
if c  w
w
E
E  c;
E  c; w
pC ; p E
2
2
>
>
!
>
>
E
E
>
c w
c 2w

>
>
if 0  w
>
E  c:
: 6 3 ;
3
Fig. 1 (a)(c) depicts the equilibrium of the basic model with ecommerce, which depends on the value of w
E . In Fig. 1(a), w
E is
sufciently high that the C-retailers do not change their price after
e-commerce appears. The E-retailer cannot obtain positive
demand even if it sets the price equal to its marginal cost. In
Fig. 1(b), w
E is in the intermediate range. The E-retailer sets the
price equal to its marginal cost, but still has no demand because the
C-retailers lower their prices. In Fig. 1(c), w
E is sufciently low that
the C- and E-retailers share the market and both retailers have
positive demand.11
3. Extended model
We extend the basic model with e-commerce by incorporating
the heterogeneity of consumers. We assume that there are two
11
Note that Assumption 2 excludes an equilibrium where the E-retailer takes all
the market and the C-retailers obtain no demand.

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

242

types of consumer: one has access to the Internet, while the other
does not. Thus, the former has a choice to buy the product from a
C-retailer or from an E-retailer, but the latter needs to buy it from a
C-retailer, if she wants the product. This setup follows Balasubramanian (1998). Hereafter, we call the former young, and the
latter old, respectively. We denote the proportion of the young in
all consumers by l. If l 1, then the model is reduced to the basic
model. If l 0, the E-retailer cannot gain any demand, thus does
not enter the market. We assume that 0 < l < 1. We use subscript #
to denote an equilibrium value of the extended model.
Given that pCj < v  c, we describe the demand of the old for Cretailer i as follows:
DCO

c pCj  pCi
2c

pCj  c  pCi  pCj c:

if

(9)

On the other hand, given that pCj  p E  pCj c and p E  v, we

describe the demand of the young for C-retailer i as follows:

DCY
i

8 E
p  pCi
>
>
<
c

pC c  pCi
>
>
: j
2c

if
if


pCj c  pCi  p E ;


pCj  c  pCi  2 p E  pCj c :

2 p E 

(10)

Using (9) and (10), we obtain the demand of all consumers for
C-retailer i when pCj  p E  pCj c,

DCi

CY
CO
l
8Di 1  lDi
C
C
>
c

p
>
j  pi
>
>
1  l
>
>
2c
>
<
E
C
c pCj  pCi
l p  pi 1  l
>
>
c
2c
>
>
>
pC c  pCi
>
>
: j
2c

if

p E  pCi  pCj c

if

2 p E  pCj c  pCi  p E ;

if

pCj  c  pCi  2 p E  pCj c:

Next, we describe the demand for the E-retailer. This demand is

the same as (4) except that the density of the demand is l, instead
of one. Thus, given that pCi pC for i 1; 2 and pC 2c < v, it is
represented by
DE p E ; pC l

c 2 pC  2 p E
c

pC

if

Fig. 2. Prot maximization price of each C-retailer in the extended model.

pC  p E  pC

8
>
>
c
>
>
>
>
>
c
>
>
>
pE 
>
<
2
2l p E 1  lc
>
>
>
>
>
1 3l
>
>
>
>
>
>
:
c

if
if
if
if

c
:
2

(12)

(11)

marginal revenue intersects with its zero marginal cost at two

distinctive points.
Taking the above into account, we obtain the following lemma:

Lemma 2. Suppose Assumption 1. In the extended model with

heterogeneous consumers, the symmetric prot maximization price
of each C-retailer depends on p E as follows12:

3
c  p E < v;
2
3l
3
c  p E < c;
21 lp 2
2

1 3l

1  l  1  l
3l
c  p E <
c;
l3
21 l
p
5l
2
1  l  1  l
p E 
c:

The supply side of the model remains unchanged. C-retailer i (the

C
E
E
E-retailer) maximizes its prot Pi pCi DCi (P p E  w
E D ). We
also maintain Assumption 1 and Assumption 2 in this section.
The important feature of the extended model is that (11)
bends outwardly at pCi p E . That is, @DCi =@ pi 1  l=2c
if pCi > p E , while @DCi =@ pi 1 l=2c if pCi < p E . This is
because C-retailer i additionally obtains the demand of the young
by lowering its price below p E . This outward kink of demand
produces the possibility that there exist two different prices that
locally maximize its prot given other retailers price, because its

(13)

Fig. 2 depicts (13). The important difference between Eq. (7) and
Eq. p
(13)
is that
the latter has a discontinuity. Note that, if 1

3l 1  l2  1  l2  c= l3 5l  p E < 3 lc=21 l,

one C-retailer maintains a price equal to 2l p E 1  lc=1
3l if other C-retailer does. On the other hand, if
12
To be strict, we must also examine the case where DCi is derived under the
condition p E < pCj . However,
we omit
this case, because we can obtain the same

p
result: pC c if p E  1  l2  1  lc=l, as we do with (11) when
pCj  c < p E < pCj . We also point out that there is no equilibrium when p E  pCj  c.

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

p
2
p E  1  l  1  lc=l, one C-retailer has an incentive to
raise its price up to c if the other C-retailer also raises and sets its
price equal to c. This means that they abandon the demand of the
young and stick to that of the old. Such behavior is more protable
when the E-retailers price is sufciently low. Therefore, there
are multiple prot maximization prices of each C-retailer when
p
p
2
2
2
1 3l 1  l  1  l c=l3 5l  p E  1  l  1
13
lc=l.
Consider the problem of the E-retailer. Given that pCi pC for
i 1; 2 and pC c=2 < v, we obtain the same prot maximization
price for the E-retailer as in the basic model: (8). This is because the
8
>
>
<

irrespective of pC . In this case, a segmented equilibrium, in which

each C-retailer sells the product only to the old and the E-retailer
obtains all the demand of the young, are possible when
p
p
2
2
w
E  1  l  1  lc=l. Moreover, when 1 3l 1  l
p
2
2
E
1  l c=l3 5l  p  1  l  1  lc=l, both a
shared equilibrium and a segmented equilibrium are possible
and multiple equilibria arise. However, in the following, we
analyze the shared equilibrium of the model with the assumption
of a monopoly E-retailer.
From (15) and Table 1, the upper limit of the demand (or market
share) for the E-retailer in equilibrium is given by

q
1
2
2
l 5l 2  21 l 1  l
DE#  5l 3
l3 l
>
>
:
21 2l

change of the demand density from one to l does not affect the Eretailers maximization problem.
Therefore, using (8) and Lemma 2, we obtain the next
proposition:

Proposition 2. Suppose Assumption 1 and Assumption 2. The Nash

equilibrium prices of the extended model are given in Table 1, where

c
c
pC ; p E


1
1
c2  l 2w
c3 l 2w

E l;
E 1 3l :
21 2l
41 2l
(14)
(14) is a pair of prices in equilibrium where the demand of the
young is shared among all retailers. We call this a shared
equilibrium.14 In a shared equilibrium, the demand for C- and Eretailers is as follows:
D#C

lDCY
#

D#E

1l
;
2

21 2lc

3 lc  2w
E 1 l;

1
2w
E 1 l  c1  3l:
41 2lc

if

(17)

From (17), it holds that the upper limit of

DE# increases with l.
p
E
Thus,
we
nd
that
D
<
11=13

17
=13  0:529
if
#
p
0p
<
l < 5 17=26  3=26
and
that
DE# < 2=3
if
5 17=26  3=26  l < 1. As we mentioned in the Introduction,
the Japanese and US e-commerce share of retail and service
markets is still less than 5 percent. The above analysis indicates
that the small market share of e-commerce comes from the small
population of Internet shoppers (small l) and/or the high cost of ecommerce (large w
E ).
4. Social welfare
In this section, we examine the impact of e-commerce on an
equilibrium of the extended model from the standpoint of social
welfare. We briey discuss the welfare implications of the basic
model as a limit where l ! 1. We use consumer and total surpluses
as a measure of social welfare. We restrict our attention to the
equilibrium where the E-retailer obtains positive demand. This is
because total surplus will not change if the demand of the E-retailer
is zero. Thus, from (15), we replace Assumption 2 with the next:
Assumption 3. 0  w
E < 3 lc=21 l.

(16)

Note that it is not possible that each C-retailer sells only to the
p
E and l  5=26 17  3=26. This
old in equilibrium if w
E <w
p
comes from the fact that 1  l2  1  lc=l < c; if each
C-retailer sets its price equal to c and sells only to the old, then
the E-retailer obtains all the young demand and raises its price to
p E c to maximize its prot. However, if p E c, then each Cretailer lowers its price pC 1 lc=1 3l. Therefore, nonexistence of a (pure strategy) equilibrium occurs in the extended
model when w
E and l are sufciently low.
On the other hand, if we adopt the assumption that many Eretailers enter the market and there is no product differentiation
among them as in Nishimura (1995), it holds that p E w
E
13

5 p
3
17  ;
0<l<
26
26
5 p
3
17 
 l < 1:
26
26

if

(15)

where D#CY is the equilibrium demand of the young for each Cretailer given as
DCY
#

243

In the extended model, an asymmetric equilibrium where one C-retailer sets

the price different from another C-retailers price may be possible, but we do not
examine it in this paper.
14
When l approaches to one, (14) converges to c=6 w
E =3; c 2w
E =3, which
is a pair of equilibrium prices in the basic model. See Proposition 1.

4.1. Consumer surplus

Consumer surplus without e-commerce is given as
CS 2

DC
0

v  pC  cxdx:

(18)

Table 1
Equilibrium price of extended model.
Equilibrium prices pC# ; p E#

Condition of w
E

When 0 < l < 1

c; w
E

if 32c  w
E <v

w
E  12c; w
E
p
5
3
 0:678
When l < 26 17  26
c
c
pC ; p E

3l
21l c

w
E  32 c

E  w
if w
E<

No Nash equilibrium
p
5
3
When 26
 l<1
17  26
c
c
pC ; p E
2

3l
c
21l
E

if 0  w
E <w

if 0  w
E<

p
 cl  5l  4 41 2l 1  l2 =2l5l 3.
Note: w
E

if

3l
21l c

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

244

On the other hand, consumer surplus with e-commerce is given

as
" Z
CS# l 2

CY
D#

v 

" Z
 l 2

D CO
#
0

From (18)
proposition:

pC#

 cxdx

CY
12D#

#
p E# dx

v 

v  pC#  cxdx :

and

(19),

we

can

(19)
obtain

the

following

Proposition 3. Suppose Assumption 1 and Assumption 3. Then, it

always holds that CS# > CS in a shared equilibrium.
That is, e-commerce always enhances consumer surplus in
equilibrium where the E-retailer obtains positive demand;
both young consumers who purchase the good from the
E-retailer and those, whether young or old, that purchase the
good from a C-retailer obtain benet from the start of
e-commerce.
From the above analysis, we nd that e-commerce strengthens the competition in the retail market, which is desirable for
consumers. It is natural to consider this outcome to hold
when we use total surplus as a measure of welfare. However, as
we will show subsequently, it is not necessarily true in some
cases.
4.2. Total surplus
Total surplus without e-commerce is given as
TS 2

1=2

v  cxdx v  1=4c;

(20)

while that with e-commerce is given as

" Z
TS# l 2

DCY
#

v  cxdx

" Z
1  l 2

Z
0

DCO
#

12DCY
#

#
E

v  w
dx

v  cxdx :

(21)

Then, using (20) and (21), we obtain the next proposition:

Proposition 4. Suppose Assumption

1 and Assumption 3. In a
p
shared equilibrium, when
73=14  5=14  l < 1, it holds that
TS# < TS if and only if w
E > 1 7lc=23 7l; otherwise it
always holds that TS# < TS .
This proposition shows the possibility that e-commerce
reduces total surplus when the marginal cost of the E-retailer
(w
E ) is large and/or the population of young consumers (l) is small,
although Proposition 3 presents that it always increases consumer
surplus.
This counter-intuitive result is explained as follows. First, part
of total surplus in the market of the old consumers remains
unchanged because the benet that they obtain comes totally from
the reduction of the C-retailers prot. Next, the benet that young
consumers gain may be overwhelmed by the reduction in the sum
of all retailers prots because the equilibrium market division
among the C- and E-retailers is not necessarily the optimal one that
maximizes total surplus; when w
E is high enough, there exist
young consumers located at the point x which satises p E# < pC#
cx and w
E > cx. That is, after the appearance of e-commerce, the

Fig. 3. Change of total surplus in a shared equilibrium.

private cost of purchasing the good decreases, but the social cost of
the purchase
p increases for some consumers (see Fig. 3). Suppose
that l  73=14  5=14  0:253. Then, the benets and costs
cancel each other out when w
E 1 7lc=23 7l.15 When w
E
is lower than this value, the benets overwhelms the costs and the
total surplus increases.
The above result is closely related to Lahiri and Ono (1988)
although their model is a quantity-setting Cournot model while
ours is a price-setting Bertrand model.16 They showed that
national welfare increases if a rm with a sufciently low share
is removed from the market. Similarly, from (17) and
Proposition 4, we know that an equilibrium with a small
land/or large w E entails a small market share of the E-retailer
and reduces total surplus.
Finally, using (15), we derive the condition that determines the
level of total
p surplus when the population of young is large such
that l  73=14  5=14 as the corollary of Proposition 4:

Corollaryp1.
In a shared equilibrium with many young consumers
such that 73=14  5=14  l < 1, it holds that TS# < TS if and only if
DE# < 4l=7l 3.
Because 4l=7l 3 increases with l, the upper limit of DE#
below which the total surplus decreases with e-commerce is
lim l ! 1 4l=7l 3 0:4. That is, even if all consumers can do
their shopping via the Internet, social welfare decreases when the
market share of e-commerce is less than 40 percent. This upper
limit value is surprisingly high. To sum up, our analysis casts doubt
on the unreserved admiration for e-commerce, because there may
exist welfare loss due to too high social cost of distribution in an
equilibrium with e-commerce.
5. Concluding remarks
In this paper, we have constructed a linear city model
incorporating electronic commerce (e-commerce). In this model,
two conventional retailers (C-retailers) and one electronic retailer
(E-retailer) compete with each other. We have also introduced the
15
When l approaches to one, w
E 1 7lc=23 7l converges to
w
E > 2=5c, then e-commerce reduces total surplus in the basic
E 2=5c. If w
model.
16
See also Zhao (2001) and Wang and Zhao (2007). Both these studies extend the
analysis by Lahiri and Ono (1988) in several ways.

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

diversity of consumers such that some consumers (young) can

purchase the good via the Internet while others (old) cannot into
the model. We derived a shared equilibrium where the demand of
the young is shared among all retailers. We also showed the
nonexistence of a segmented equilibrium where each C-retailer
sells the product only to the old and the E-retailer obtains all the
demand of the young under the assumption of a monopoly Eretailer. We then compared the welfare properties of the
equilibrium with e-commerce to that without it.
Our main result is as follows. The appearance of e-commerce
always lowers retail prices and increases consumer surplus in a
shared equilibrium. However, it does not mean that social welfare
measured as total surplus improves concurrently. This is because
there are cost inefciencies associated with the equilibrium
market division between C- and E-retailers, which is similar to
Lahiri and Ono (1988). Based on our model, we indicated empirical
evidence of the small e-commerce market share in the Japanese
and US economies is because of a small population of Internet
shoppers and/or high cost of e-commerce and may result in
welfare loss. However, we have to point out that our model ignores
a variety of welfare-enhancing features of e-commerce (e.g., a
broad assortment of products and a recommendation system
based on personal and others purchase history). These features
may reverse the above result.
We conclude with some qualications of our results. First, we
take the number of retailers as given. However, when we fully
examine the long-run effect of e-commerce on our economy, we
must explicitly consider the free entry of all retailers and take their
number as endogenous variables. Second, we take the infrastruc-

pCi

8
c pCj
>
>
>
>
>
>
2
>
>
>
>
>
E
C
>
> 2 p  c p j
<
E

>
2l p 1  lc
>
>
>
>
>
21 l
>
>
>
>
C
>
c

p
>
j
>
:
2

Appendix A
Proof of Lemma 1. Given pCj that satises pCj < v < pCj c, the
prot maximization price of C-retailer i given pCj is as follows:
8
v
3
>
>
if pCj  v  c;
>
>2
2
>
>
<
4
3
C
C
v  c  pCj < v  c;
(A.1)
pi 2v  p j c if
3
2
>
>
>
> c pC
>
>
4
j
:
if pCj < v  c:
3
2
Note that asymmetric prices ( pC1 6 pC2 ) cannot be possible in
equilibrium because of the symmetric structure of demand and
cost. Thus, using (A.1) and the symmetric condition, pCi pC
(i 1; 2), we obtain (2). &
Proof of Proposition 1. If the pair of prices pC ; p E satises both
(7) and (8), then it is in a Nash equilibrium. It depends on the value
of w
E . pC ; p E denotes a pair of equilibrium prices.
(a) If 3=2c  w
E < v, then pC c and p E w
E intersect at
E
E
C
pC ; p E c; w
.
(b)
If
c

w

3=2c,
then
p

p E  c=2 and

p E c=4 pC w
E =2 intersect at pC ; p E w
E  c=2; w
E . (c)
E
E
E
E
C
C
If 0  w
 c, then p p =2 and p c=4 p w
=2 intersect at pC ; p E c=6 w
E =3; c 2w
E =3. &
Proof of Lemma 2. First, with (11), we nd that C-retailer is
(possibly local) prot maximization price given pCj and p E is as
follows:

if
if
pCj

245

3
p E  c pCj ;
4
3l
3
c pCj  p E < c pCj ;
4
22 l

if

1l
3l
c pCj  p E <
c pCj ;
2
22 l

if

p E 

c pCj
2

(A.2)

ture to affect costs of online and ofine shopping as given.

However, the governments infrastructure policy can affect the
number of retailers and the welfare of consumers by accumulating
various public capital to reduce the cost of shopping. Thus, it is
important to examine the effect of the governments infrastructure
policy on an economy with e-commerce. Finally, we examined the
retail market only and abstract upstream markets from our model.
However, opening an additional trade channel depends on
manufacturers. Thus, we must examine both retail and wholesale
markets to fully understand the impact of e-commerce, as Chiang
et al. (2003) did.17 These are important research issues for the
future.

There exists a unique local maximization price, unless

1  lc pCj =2  p E  c pCj =2. Thus, it is also the global
maximization price. If 1  lc pCj =2  p E  c pCj =2, there
exist two local maximization prices, pCa 2l p E 1  lc
pCj =21 l and pCb c pCj =2. We must examine which
attains the global maximum. Substituting pCa and pCb into the
corresponding C-retailer is prot, we obtain
1
2
2l p E 1  lc pCj  ;
PCia p E ; pCj
8c1 l
1l
2
c pCj ;
PCib p E ; pCj
8c

Acknowledgements

respectively. It holds that Pia  Pib if and only if

p
p E  1  l2  1  lc pCj =2l. Therefore, when 1  l

The author would like to thank the participants of a seminar at

Sophia University and the anonymous referee. Their comments
and suggestions improved enormously the contents of this paper.
All errors herein are of course my own. Financial support from the
Japan Society for the Promotion of Science (JSPS) through a Grantin-Aid for Young Scientists (B) (No. 19730285) is gratefully
acknowledged.
17

Nakayama (2007) attempts such an analysis.

c pCj =2  p E  c pCj =2, the global prot maximization price

is described by
8
>
2l p E 1  lc pCj
>
>
>
if
<
21 l
pCi
> c pC
>
>
j
>
:
if
2

p
1  l2  1  l
c pCj  p E ;
2l
p
1  l2  1  l
p E 
c pCj :
2l
(A.3)

246

Y. Nakayama / Japan and the World Economy 21 (2009) 239247

Next, using the symmetric price condition ( pCi pC for i 1; 2)

and the above result, we can derive each C-retailers prot
maximization price given p E : the symmetric price condition and
pCi c pCj =2 yield pC c. Substituting this price into the
condition p E  3=4c pC , we obtain p E  3=2c. Following a
similar procedure in all cases, we obtain the global prot
maximization price of each C-retailer given p E as (13).

which is positive, because it holds that pC > pC# and DE# > 0 in
equilibrium. &
Proof of Proposition 4. (21) is reduced to
2

1
TS# lv  1  2DCY
E  cDCY
# w
#  1  lv  4c:

(A.7)

Note that it holds that

PCia p E ;

2l p E 1  lc
1 3l

 Pib

p E ;

2l p E 1  lc
1 3l

PCib p E ; c  PCia p E ; c

!
if

if

p
1 3l 1  l2  1  l2
3l
c  p E <
c;
l3 5l
21 l
p
1  l2  1  l
p E 
c:

Therefore, C-retailer i has no incentive to change the price pCi

2l p E 1  lc=1 3l (or pCi c) if another C-retailer sets
pCj 2l p E 1  lc=1 3l (or pCj c) when p E satises 1
p
2
2
3l 1  l  1  l c=l3 5l  p E < 3 lc=21 l
p
2
E
(or p  1  l  1  lc=l). &
Proof of Proposition 2. If a pair of prices pC ; p E satises both (8)
and (13), then it is in a Nash equilibrium. It depends on l and w
E . In
the following, pC# ; p E# indicates a pair of equilibrium prices.
From Eq. (8) and Eq. (13), for any l such that 0 < l < 1, we can
easily show that: if w
E ; If
E  3=2c, then pC# ; p E# c; w
3 lc=21 l  w
E < 3=2c, then pC# ; p E# w
E  c=2; w
E .
p
2
2
When p E 1 3l 1 l  1  l c=l3 5l, it holds
p
that pC 2l p E 1  lc=1 3l 1  l 2 1 l2 c=3
p
5l. For the pair, pC ; p E 1  l 2 1  l2 c=3 5l; 1
p
2
2
3l 1  l  1  l c=l3 5l, to be an equilibrium, from
E  cl2  5l  4 41 2l
(8), w
E must be equal to w
p
2
1  l =2l5l 3, whichpisa decreasing function of l and it
E  0 when l  5 17=26  3=26 0:678.
holds that w
p
Suppose that l  5 17=26  3=26. If 0  w
E < 3 lc=
c
E
E
c
C
21 l, then p# ; p # pC ; p in (14). On the other hand,
p
E , there exists no
suppose that l < 5 17=26  3=26. If 0  w
E <w
pair pC ; p E that satises both Eq. (8) and Eq. (13). If
c
E  w
pC ; p E . Table 1
w
E < 3 lc=21 l, then pC# ; p E# c
summarizes the argument. &
Proof of Proposition 3. Under Assumption 1, it holds that
DC 1=2. Thus, (18) is reduced to
CS v  pC  1=4c:

(A.4)

On the other hand, under Assumption 3, (19) is given as

"



 #
1
1 E
1
1 E 2
CS# l v  pC#  c


D# c
D#
2 2l
2 2l

 1 
(A.5)
1  l v  pC#  c ;
4
where we use
DCO
#

E
pC# cDCY
E# , DCY
# p
# 1=2  1=2lD# and

1=2.

From (A.4) and (A.5), we nd that

2

CS#  CS pC  pC# c=4lDE# ;

(A.6)

From Eq. (20) and Eq. (A.7), we have

2

TS#  TS l14c  1  2DCY

E  cDCY
# w
# :

(A.8)

Rearranging (A.8), we obtain

1
TS#  TS l12  DCY
E  cDCY
# 2w
# 2:

(A.9)

Substituting (16) into the bracket of the right hand side of (A.9),
then we obtain


3 7l
1 7l
w
c ;
(A.10)
E 
21 2l
23 7l
which we will denote as f l; w
E in the following.
Note that DCY
# < 1=2 in a shared equilibrium. Thus, we nd that
p
TS# < TS if and only if f l; w
E > 0. If 0 < l  5 17=26  3=26, then
from Table 1, the lower limit of w
E under which a shared equilibrium
E.
w

is

Substituting

E
w
E w

into (A.10), we nd
p
E c7l 11l 6  27l 3 1  l2 =2l5l 3.
f l; w

holds

E is a decreasing function of l and it holds that

Note that f l; w
p
E
> 0 if and only if l < 73=14  5=14  0:253. Thus, it is
f l; w
p
found that TS# < TS when 0 < l < 73=14  5=14 and
E  w
w
E < 3 lc=21 l. On the other hand, when
p
p
E  0.
73=14  5=14  l < 5 17=26  3=26, it holds that f l; w
E
Thus, we nd that TS# < TS if and only if w
> 1 7lc=23 7l.
p
Similarly, if 5 17=26  3=26  l < 1, a shared equilibrium holds
when 0  w
E < 3 lc=21 l. Note that f l; 0 < 0. Thus, it
holds that TS# < TS if and only if w
E > 1 7lc=23 7l.
Summarizing the above argument, we obtain this proposition. &
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