When I wrote that paper I thought of micropayments as payments of a granularity smaller than the 1 cent granularity of traditional prices, or very close to it. My prediction was that the granularity of payments on the Internet would be somewhat higher than traditional price granularity. This was in a response to the fascinating Digital Silk Road/Agorics idea that you could buy and sell IP packet transmission, memory space, and the like at unprecedentedly low granularities like a thousandth of a cent. There is basically no important computational transaction cost barrier to such payments, but I described mental transaction cost barriers that still have not been surmounted. The efforts of micropayment engineers focusing on computational rather than mental transaction costs were and are misguided.
So when the Post Office raises postage rates by 1 cent, or charges a few cents more for one class of mail than another, that's very close to what I thought of as a micropayment and is what I was predicting would be very hard (not impossible) to do productively on the Internet. But when iTunes sells a song for a dollar, regardless of how popular the song is, that's a price granularity that is sufficiently high to overcome mental transaction costs. Nowadays many people call even a dollar a "micropayment" because it's smaller than your typical credit card payment, and this muddles the issue. Paypal and some services like iTunes have shown that there's at least a significant niche market below typical minimum credit card payment, but it hasn't shown that micropayments of the kind I talked about are feasible.
I don't claim that price granularities of near 1 cent or below will never make economic sense on the Internet, but they do require a sophisticated attention to preference revelation and mental transaction costs that so far has generally been lacking. Something like micropayments, or at least low-granularity accounting, is happening on the advertising payment end rather than the consumer payment end. The business of selling eyeballs wholesale is much better able to automate the sophisticated accounting and auditing that is required for such schemes to work. Some proxy measures for eyeballs, e.g. based on "hits", have proven to be feasible when computers rather than humans can reliably do the counting at any granularity below thousands. Arguably some online games have also achieved low price granularities, although here payments are part of the entertainment value of the game (as in traditional games like Monopoly(tm)) rather than just a necessary transaction cost.
The extent to which iTunes and the like can compete with free content is another issue which Shirky describes well. This competition interacts with price granularity insofar as the mental transaction costs put a floor on content prices and competition from free content (artists seeking fame rather than money) puts a ceiling on content prices. Shirky plausibly argues that there is little or (ultimately) no room in between this floor and ceiling leaving little and perhaps ultimately no significant market for online content funded directly by the consumer.
Here are a couple more aspects of micropayments and price granularity I have long believed but I'm not sure I've sufficiently made clear:
(1) As more low-wealth people get on the Internet, price granularity will naturally fall as such consumers are generally willing to put more effort and attention into shopping per money saved. Much of the reason price granularity has been higher on the Internet is because its users have higher than average wealth. However, unlike point (2) below this effect is not very large and won't by itself get us below traditional price granularities.
(2) Where the mental transaction/preference revelation problem can be solved for high-wealth consumers at 1 cent granularity for a particular kind of Internet transaction, there is nothing magical about 1 cent, and it might well be easy to further reduce price granularity to a thousandth or a millionth of a cent. In that sense I'm a big fan of the agorics approach -- since "micropayments" has been taken to include much larger payments perhaps we could call them "nanopayments" -- and I hope I haven't overly discouraged people from looking at these fascinating and potentially quite lucrative and revolutionary possibilities.