Monday, December 30, 2002

Economics and charity

Jane Galt has an excellent post today about charity and the government. I worked for an anti-hunger non-profit in DC (Share Our Strength) and one of the things they were great at was encouraging people to give their time, not just their money, one of the things Jane discusses in her post.

Onto the economics. Questions of "should charity be provided by the government or individuals" aside, you can ask whether charitable contributions should be tax deductible. Classical economics would be pretty comfortable with that because of the externalities in charity -- for not only does your charitable contribution do you good (because it makes you feel better), it presumably also helps the person receiving the contribution. But since you don't really feel the "happiness" experienced by the recipient, you end up not giving enough. A tax deduction lowers the price of charitable giving and thus increases its quantity, getting us closer to the appropriate amount. (The trade off is higher marginal taxes which slow economic growth and reduce wealth overall).

Not feeling the "happiness" experienced by the charity's recipients also makes us end up giving to sub-optimal causes, and so reduces the quality of charitable giving. Since we don't know how effective a non-profit is at using the money, we may not support the most productive ones, and we may also give to things we feel are important to us, but may not be that valuable to the poor recipient.

Chicago's Judge Posner argues that nonprofits' operating constraints (which, among other things, cap salaries and expenses as a proportion of revenue) are designed to tackle some of the quality problems. By limiting the organization's ability to make profits and limiting salaries, it will be forced to maximize output, which is the least worst we can hope for since it's much easier to track how much "good" a charity is doing than how "good" that "good" is. And if you go to your average non-profit, you'd see lots of stats measuring outputs, but very little measuring "outcomes".

This focus on output over outcome creates its own wacky pathologies that are really really hard to fix (I've worked in this field, take my word for it). Giving allocation control to those who use the services, by giving poor people cash, may improve their wellbeing, but it reduces their incentive to work, and society is uncomfortable with that type of unrestricted redistribution (except where taxes are involved). Anyway, go read Jane's post, where she discusses exactly these issues at greater length.

Thursday, December 26, 2002

Coase and Lighthouses

I read a series of lectures Coase wrote in the 50s and was struck by how lucid and insightful his thinking was. I've been reading D-Squared Digest (Daniel Davies) for a few months and while some of it is quite fun, it's not Coase (no offense intended). Imagine my surprise when I see " Score: Daniel Davies, 393; Ronald Coase, 0" on J Brad DeLong's site.

It turns out to center on an argument between Coase and Samuelson on lighthouses. Samuelson posited that lighthouses are a "public good" in that, since it is very hard to charge for the services lighthouses render, there will be no lighthouses unless the government steps in and provides them. Coase looked at the history books and found that there were lighthouses before the government stepped in to provide them (1836), and they were paid by charging ships when they came into port (so much so for "public goods" then). D-Squared Digest then looks at the history books more closely, and notes that Henry III created a a Royal Patent dated 1261, where some private individuals can collect "light duties" from shipping to pay for the upkeep of a light house. He goes on to argue that this sort of "mandatory duty" does not jibe well with the free-market / free-participant negotiations Coase implied sorted out the lighthouse problem long before the government got involved. OK.

D-Squared Digest generally paints a false caricature of Chicago style economics, and this most recent post is no different. While Daniel claims a "mandatory duty" does not seem like a typical free-market, to me it sounds like backward integration by consumers to set up a two-part tariff regime to provide a necessary service where a more classical free market is not possible.

Here's what I mean. When you have a good with a marginal cost of zero (like light from a lighthouse, or an mp3) you face the problem of covering your upfront, fixed costs (like building a lighthouse, or recording a song for the first time). This is a very tricky area, and no solution works very well, but one common system is the "two part tariff" where a consumer pays some upfront cost to "enter" the market, and then pays the marginal cost after that. The upfront "entrance fee" covers fixed costs, while the marginal price after that covers marginal costs. In the lighthouse example, ships had to pay an upfront fee (in the form of a port tax) to sail around, where they consumed light from lighthouses for their marginal cost (zero).

To me this seems to fit perfectly well within the neo-classical economics systems. Chicago school economics is not against government regulation per se, it just feels that governments should support markets and let individuals sort it out from there, and that governments should not engage in social engineering. In the lighthouse example, private parties (the sailors) needed a two-part tariff system to create a market for a good they needed but would not otherwise be provided (lighthouses). They contracted with other private parties (ports) to arrange this, and the government supplied the legal infrastructure needed to support that market (making paying the tax mandatory).

Samuelson's public good argument had the entire population paying taxes to support lighthouses only used by sailors (which seems strange) and after 1836, the government itself started to operate lighthouses (which seems even stranger since private individuals were already doing that just fine). And perhaps most bizarrely, Daniel notes "...there are numerous accounts of "rent-seeking" behavior in lighthouses, whereby lighthouse entrepreneurs with good political connections sought to build unnecessary lighthouses in anticipation of the stream of light duties they would be allowed to extract" as if this refutes the neo-classical interpretation of what would happen in the market and seems to deny that exactly the same sort of rent-seeking would go on if the government ran lighthouses itself. Note how, in the US, states lobby for all kinds of unnecessary pork-barrel public works projects that seek only to transfer wealth from other states to their own.

I'll will also note that in 1995 in Britain, there were 56 automated lighthouses, 11 staffed lighthouses, 10 automated lightvessels, 2 automated lightfloats, 2 large automatic navigation buoys (lanbys), 414 buoys (of which 94 were unlit), 26 beacons, 62 radar or radio beacons, and 11 Decca Navigator stations. All in an age where a GPS system costs about $100. I'm not saying there would be more or less of these things if the government was not in the business of lighthouse provision and therefore had a bureaucracy invested in lighthouses, I'm just sayin'.

Wednesday, December 25, 2002

Merry Christmas!

Merry Christmas and Happy Holidays to all winterspeak readers!

Monday, December 23, 2002

Will Microsoft buy Macromedia?

When I worked at Creative Good, Flash (and by extension, Macromedia) had a terrible name. Flash animations were only seen on websites, and they inevitably made those websites more irritating and difficult to use. Sean Martin (of IBM) pointed out to me a few months ago that Flash is actually a serious attempt to offer easy and rapid application development that extends across the client and server for novice "script" coders. I've written on this site many times about how easy to use Microsoft's old VB IDEs were, and how (with .NET) they've now isolated a lot of that community. Integrating Flash within Microsoft's product suite would be a way to offer web services to novice "script" coders.

Friday, December 20, 2002

Why the US runs a surplus even when it's in deficit

The newspapers are full of people warning that the US government, which used to run a surplus, is now plunging into deficit and that will lead the country to ruin. This is wrong.

Over time, the tax receipts a government takes in has to equal its expenditure out plus all outstanding debt.

Tax in over time = Expenditure over time + Outstanding debt

But government accounting includes interest payments on outstanding debt as an expenditure, when it isn't. That means that all the interest on debt that the US government pays (which is quite a lot) should not be counted as an expenditure in real economic terms, even though it is in accounting terms. Once you add back interest payments, taxes in once again become larger than expenditures out, and the government in back in surplus.

Those of you who are still awake are angry because this seems to make no sense -- how can making interest payments not count as an expense? Think about it this way: if you loaned me $100 at 10% interest rate for 2 years, I'd pay you $10 in year 1, $10 in year 2, and your $100 in principal back in year 2 also. If you loaned me $100 at 10% interest rate for 10 years, then I'd pay you $10 every year for 10 years, and include a $100 payment in year 10 on top of everything. All else equal, if you were willing to loan me $100 at 10% for two years and ten years, then why not loan it to me for 1,000,000 years? I'd pay you $10 every year, and in year 1,000,000 I'd pay the $100 back. But $100 1,000,000 years from now is worth about 0, so why don't I never pay the principal back and just pay you $10/year.

The point is that making interest payments on debt is the same as paying down the debt. So long as your ability to make interest payments is never called into question, then you don't actually need to reduce the debt to 0, you can just carry it infinitely. In fact, there is no different between carrying the debt and paying interest on it infinitely, and not having the debt at all. The opportunity cost of not having the debt precisely equals the interest you're not paying on it.

True deficit spending is when expenditures out (excluding interest payments on debt) > taxes in, which increases outstanding debt. The US has gone through periods like this, but it was in surplus for quite some time before the surplus "officially" began and is in surplus still, even though in accounting terms it is now running a deficit.

Wednesday, December 18, 2002

What is cost?

It's useful to contrast this nostalgic piece on rural America with this article concerning water rights in California. Essentially, the subsidized farmers in the Imperial Valley pay $15.50 per acre-foot for water, while nearby San Diego pays $258 an acre-foot. So, what is the real cost of water to Imperial Valley farmers?

"Cost" is not about money, it's about what you have to give up to get something else, and money is merely a medium of exchange. One way to think about rich people is that "they have a lot of money", and another way to think about it is "everything, to them, is cheap" because they don't have to give up much to get stuff. This means the "subsidized" Imperial Valley farmers actually pay $258 per acre-foot for their water because this is the amount of money they have to give up by not selling their water to San Diego for that price. That's a healthy chunk of change, and I don't think most Imperial Valley farmers value water that much.

Which brings us back to the nostalgia piece. If the value of something you own goes up, then so does the cost of you using that thing (because you bear the opportunity cost of not selling it to someone else). And if you don't use that resource in the most productive way, then you bear the costs of that inefficiency too. That's not to say the cost may not be worth it, but let's be honest about the cost being there. The only folks who can make a cost/benefit trade-off are those who enjoy all the benefits and bear all the costs. Nostalgics, like tourists, do not fit in this category and so are unreliable guides to "what is best"--their sense of "what makes me feel most good" is too short and narrow to make a useful proxy.

But that's not to say that nostalgia isn't a powerful force, nor does it mean there is not real disruption when reality changes prices and makes something that used to be cheap (rural American land) very expensive. Personally, I would prefer to see disenfranchised groups be paid off because it seems more humane than charging them $258 per acre-foot for "free" water. But there seems to be something deep about human psychology that makes economics (which is really pretty simple) often so counter-intuitive and emotionally distasteful. (link via Arnold Kling)

Oracle, Sun, IBM, and Eclipse

Eclipse is IBM's open source IDE for Java. There are very clear and obvious reasons while it's called "Eclipse", so it's funny to see Sun using Oracle to try and reign it in.

Tuesday, December 17, 2002

Lessig & Epstein

This FT piece has Lessig & Epstein commenting on the whether or not open access provisions should apply to broadban providers. My sympathies are broadly with Epstein. Essentially, as I've documented many times before on this site, broadband internet access makes you choose between two of the following three: a) competition at the service level, b) competition at the infrastructure level, or c) investment in new infrastructure.

The Telecom Act of '96 required incumbent telco's to offer entrants access to their equipment (unbundled network elements, UNE) at marginal cost, which reduced investment in new infrastructure and forced telcos to offer special online services (which Lessig derides in his piece as being dangerous and discriminatory). If new legislation forced common carrier provisions on broadband service providers AND kept the UNE requirement, then incumbents would stop upgrading their facilities because they would have no incentive to do so.

Lessig, like many others, fears that incumbents will censor parts of the internet and charge high prices, but as Epstein argues, they have no incentive to do so as restricting access will merely reduce the value of the service to customer and so reduce their profits. As things stand now, the legislation is a subsidy to entrant telco providers (who do not invest in plant) and content industries. If people have examples of swathes of the Internet broadband providers are cutting of for profiteering reasons, I'd like to hear about them.

Monday, December 16, 2002

Step 3:

This is so nice. I just licensed winterspeak under the Creative Commons Attribution-NonCommercial-ShareAlike License 1.0. If you think that's a mouthful, read the text here.

Why is this important? After all, I was perfectly willing to spend my time writing all this stuff for free long before Lessig & Co. came up with this Creative Commons license, and it's the oodles of free online content that gives paid content providers the willies. What's important is that my site is machine readable, meaning it can be read by news aggregators like the excellent Net NewsWire Lite AND the Creative Commons license is also machine readable, meaning it too can be read by news aggregators. This means that any content that gets locked up by it's owner will be excluded from distribution (which is kind of the point) while open content will go forth and multiply (and conquer).

Update to "CD Price fixing"

Larry Staton writes in pointing out that the CD price fixing case I wrote about recently was settled -- there was no judgement. He is correct. I meant to say that I do not think the RIAA harmed the public through retail price maintenance since this practice can be efficient.

File trading's effect on price and quantity

A while ago I wrote how file trading effects the music industry will depend on what it does to the demand curve. Prices and quantities could go up or down. This lengthy paper (.pdf) looks at things in more details and concludes (tentatively) that file trading will reduce CD consumption by 20%-30% per capital (3.5 CDs/person/year). He also notes that quantity is falling while price is staying constant. This other post catalogs how investment in new music is falling (and erroneously says that is why sales fell--the opposite is almost certainly true) and that prices are rising slightly. So, coming back to the original post, the data suggests that file trading 1) makes the demand curve slightly more inelastic because more elastic customers are switching to mp3s and 2) record companies are responding by investing less in new bands. [Links via susupply and The Register.]

I, Cringely, has a fairly inane piece that begins well (make money off concerts) but then goes off the deep-end, suggesting record labels become VCs ("after all, they're both hit driven businesses"). Venture capitalists don't put money in risky ventures for fun, they do it because they can get profits out of it. File trading shifts profits to consumers, reducing a financier's incentive to back musicians. It may or may not reduce musicians' incentives to play, given that the chances of making any money in that business are about zero anyway.

CD Price fixing

A while ago, the RIAA was sued for conspiring with retailers to keep the prices of CDs high. The suit centered around "minimum advertised prices" where the distributors (RIAA) would pay for retailers' advertising in local media, provided the retailers did not advertise CD's at a sale price below a minimum established by the distributor. This has been settled in favor of consumers.

Long time readers of this site will know how I feel about the content cartel, but in this case I do not feel the judgement was correct (I've taken the opposite position here and here but I think I was wrong before). Collusion amongst horizontal market participants (i.e. they are all in the same industry and do the same thing) is pretty straightforward -- coordinating action lets you restrict quantity, raise price, and earn monopoly rent. But it's tempting to cheat, and since you cannot contract to enforce the cartel, your best bet is to get Congress to pass legislation that does, usually through some "just and reasonable" non-discrimination clause. (Telecom and media regulation is rife with this sort of thing.)

Collusion amongst vertical market participants (i.e. one is a wholesaler who sells to the other, who is a retailer) is a different matter altogether. Since the wholesaler can perfectly control the wholesale price, why bother the retailer with some minimum price requirement (as the RIAA did under their "minimum advertised price" regime)? After all, if I want you to sell CDs for at least $15, why don't I simply charge you $15 for them?

The answer is that wholesalers think they would be best served if the retailers invested in selling the product also. In the CD example, this could include things like 1) stocking a wide selection of music (not just the hits), 2) keeping a clean store, 3) hiring knowledgeable salespeople, 4) investing in listening booths etc. By setting a minimum retail price above the wholesale price, the RIAA has restricted record stores' ability to compete by discounting, meaning they have to compete on service instead. And being good, greedy capitalists, they've figured out that they can sell more stuff through better service than through lower price (this is not always true -- sometimes low price is the way to go). This type of thing also happens in the electronics business, where high-end audio is offered under a minimum retail price so customers can't go to one store, learn all about the system, and then buy it from a discounter.

Sunday, December 15, 2002

Hollywood vs the Future

This article (rather foolishly) declares the content wars drawing to a close because a technology company called SmartRight has agreed to provide technology that provides total end-to-end encryption for copyright technology, regional encoding, digital watermarks, and every other content control gizmo Hollywood could want. The key to all of this is whether people can put up open content if they want, and if they can (which I believe surely will happen) then every constraint Hollywood puts on its stuff is just one more reason to avoid it. And that's just fine by me.

I'm organizing a panel at the U Chicago GSB technology conference on DRM, and I want panelists to explore how DRM media will compete and cooperate with open media.

Friday, December 13, 2002

Being set straight

My old college buddy (and crack programmer) SS comments on my IBM, Microsoft, and Rational musings:
I think your last blog entry misses on a technical point- "But why does Microsoft, which already makes such great dev tools, want to buy Rational?". Their dev tools have little overlap besides source control.

The Visual Studio environment, for VB, C++, and now C#, is basically the best integrated development environment (IDE) out there. Rational has a number of products, but no IDE. Rational's major product is ClearCase, basically a source control tool, and is the premier tool on the market. MSFT's primary source control tool, SourceSafe, sucks ass. I think they bought some other company that does source control a few years ago but I know nothing about that product. Besides that, Rational makes profiling, analysis, and UML design tools that MSFT does not have, to my knowledge. So I see a potential Rational acquisition by MSFT as fairly complementary in terms of technology, price considerations aside.
So now I know better from the technical side, but I'm still flummoxed on the business side. Given that IBM already has a bid in, Microsoft will have to pay a very steep price premium to buy Rational. Their software, while complementary, seems to be the type of thing that Microsoft should be able to do quite well, so I still don't understand why MSFT thinks it's worthwhile to shell out all that dough.

And while I'm being set straight, Joel Spolsky (always worth reading) says it's vacuous to over generalize and say things like MSFT is bad at operating systems. My point was that I think Microsoft's applications are so good I wish they would ship them on cheaper OSes (Linux) so more people would buy them instead of shelling out for the overpriced bloatware most enterprise software vendors are choosing to ship. While Apple folks (and I am one of them) like to criticize Microsoft for making hard-to-use software, I encourage them to use Lotus Notes before moaning about Outlook. I think Microsoft's OS obsession is now keeping them from delivering the best apps they can deliver, and we're all poorer for that.

Thursday, December 12, 2002

IBM, Microsoft, and Rational

This report on Microsoft attempting to buy out Rational (which IBM announced it was going to buy a few days ago) is really weird.
"I just don't believe the medium-term competitive risk to Microsoft would justify some sort of huge premium here" if Microsoft were to attempt a competing bid, Sanford C. Bernstein analyst Charles Di Bona told Reuters.
I knew folks at Sanford C, and it's a level headed, smart shop, so Di Bona is probably on the money.

Some background; Microsoft makes great developer tools, and IBM makes lousy developer tools. VB is as easy to use because Microsoft worked really really hard to making it easy to use (note to Apple loyalists -- don't moan about MSFT usability until you've tried some pre-MSFT usability). IBM is a typical techno-snob and believes that if someone can't develop (or install) a platform, they're probably too dumb to have that platform in the first place. When I was at IBM over the summer, my very smart fellow interns all moaned and whined about how hard the IBM kit was to install. IBM's response? "Why are you moaning if it takes you five hours to install? It used to take five days!" *Sigh* MSFT stuff installs in five minutes.

The good news is that IBM is very serious about the software space and realizes it needs developers and good developer tools. That's why it bought Rational. IBM only has four software "brands"--Tivoli, Lotus, WebSphere, and DB2--Rational was slated to be the fifth and this is a very big deal for the company.

But why does Microsoft, which already makes such great dev tools, want to buy Rational? The only reason I can think of is to keep it out of IBM's grubby paws. This, to be blunt, is nutso. The Web standards war between .NET and J2EE is very real and very central to the competition between MSFT and IBM, but thinking you can buy your away out of it reveals an organization with lots of cash and little business sense. Office and Windows makes about 120% of Microsoft's profits, every other division loses money, and they don't seem to care. Even if XBox is viable some day, Microsoft will have spent so much money on it that the investment will have negative economic profit overall. The amount of short term advantage Microsoft may get by keeping Rational out of IBM's hands is not worth the price it has to pay for it. It seems as if Microsoft is using its monopoly money to maintain its monopoly, an example of wasteful rent seeking and a complete waste of time from a shareholder or business perspective. It also suggests that Microsoft has no ideas for how to actually grow its business.

Tuesday, December 10, 2002

MSFT apps on Linux

The Meta Group speculates that Microsoft will ship apps on GNU/Linux (server side) within two years. I've been arguing that Microsoft's applications are much better than their operating systems, and the only thing keeping them from being a force in the enterprise market is their insistence on tying applications to .NET server instead of on Linux. I also predict that MSFT will relinquish their OS addition when Apple starts licensing OS X to third party OEMs.

Spitzer v U Chicago

I suppose it's kind of a backhanded complement that Eliot Spitzer blames U Chicago for high priced drugs, corporate scandals, and dishonest banks.

Friday, December 06, 2002

Paul O'Neill is out

So O'Neill's been booted from the government. Good riddance -- from what I saw of him at U Chicago, he understood nothing about economics or the economy. But I have no confidence that his replacement will be any good, or have any influence.

Krugman on Krack

I was chatting with some U Chicago law school professors last year when it dawned on me that they really didn't understand economics very well. I checked with the Ec. Faculty across the Midway at the U Chicago Econ dept, and it turned out I was right. I get the same feeling when I read Krugman's NYTimes columns these days. His Slate pieces were very good, and his old (MIT) website was filled with thoughtful notes jam-packed with Economic goodness.

No more. View today's screed against broadband access in general, and FCC chair Michael Powell in particular. Krugman hails the Telecom Act of 96 as a wonderful piece of legislation thwarted by incumbents to block entrant competition. While I am under no illusions about the greed of the incumbent telco industry, I am also under no illusion about the greed of entrant telco companies. Under TA96, entrants gained access to incumbent's pipes at marginal cost, which understandably halted all (incumbent) investment in new equipment, keeping costs higher and contributing (in part) to the current telco meltdown. Of course, nothing stopped entrants for investing in their own new, equipment, but somehow these paragons of virtue declined. I've covered this story here and here.

Krugman then claims that telco providers will both 1) jack up broadband prices to maximize profits AND 2) restrict access to large sections of the Internet. These two things are inherently contradictory as cutting of large sections of the Internet will lower the value of access, and so reduce telco profits. But Krugman believes that these guys are some opaque combination of evil and stupid which limits their greed, harming both their profits and the public good at the same time. I, on the other hand, beleive they are merely average in their intelligence, but limitless in the greed, so consumers are quite safe in their hands.

He finished with the old trope of "media consolidation is dangerous", which I agree with from the standpoint of the content industry, but not as a consumer. I've dealt with that here. I should add that the only arena I think media consolidation might be dangerous is the political one where a locale may only be exposed to partisan news from one side (politicians agree with me here). But given other popular concerns (no one votes, people only read stuff that they agree with, no one cares about political debate) I think even the most hysterical of alarmists would agree that the damage is likely to be limited in scope.

My Krugman related point is that there are good economic arguments about why these laymen concerns really have no basis. There might be important stuff that the economics misses, but on a profit maximizing basis none of the concerns listed in the article is likely to happen. As an economist, Krugman should either make or poke holes in the economic argument, not rehash what non-economists have already asserted about the issue.

Wednesday, December 04, 2002

More economic wrongness

Jane Galt quotes Musil, incorrectly asserting how IP in the public domain too can get "overgrazed". Answer -- someone can use it in a way that gives it negative connotations and so reduces its value. Urgh. Musil gives the example of a Cole Porter song that was parodied in the toilet cleaner add, and cites the harm done to the Cole Porter estate as a result. The argument is really tortured, because the song actually was under copyright and the Cole Porter estate (productive artists all) did not charge the toilet cleaner company enough to make up for subsequent loss of sales.

This to me seems like mismanagement by owners, not any kind of "overgrazing". (Note: The whole "overgrazing" idea comes from a story called "The Tragedy of the Commons". The economic lesson behind this has been so mangled by so many people that I refuse to ever refer to it again. Just be warned, if someone refers to something as being a "Tragedy of the Commons", 90% chance it's not.)

While you can build economic models where other people's preference builds into your own (Becker, again) saying this will neccessarily happen with public domain IP is dead wrong, because a bad externality is just as likely as a good externality, if not less so. One can certainly think of more examples of public domain material becoming more valuable because of subsequent innovation on top of it (every fairy tale any one of us can think of) than less so, and public domain goods stay available more thanks to distributed filesharing.

Usability matters

Businessweek has an article on how software usability leads to profits. If usability is starting to matter, it means 1) markets are getting more competitive and/or 2) products are moving towards newer, less tech savvy customer segments. Microsoft (before VB.NET) always understood how important it was to make their stuff easy for their customers (3rd party developers) to use.

CD prices and piracy

Fellow Chicago GSB grad Jane Galt has a piece arguing that piracy will increase CD prices because, if people are getting unauthorized copies for free, labels will have to charge a higher average price to make up their upfront fixed costs. I don't think this is quite right.

Firstly, labels only need worry about making up their upfront fixed costs before deciding to launch a new CD. Once a CD is out, all that upfront stuff is sunk and shouldn't factor into pricing decisions. And since labels have a great amount of discretion over what those upfront fixed costs are (ie how much to spend on promotion, packaging etc.) they can simply change what kind of CD they support and how they market it (lowering upfront investment) instead of raising price.

So how do we know whether they will lower upfront investment or raise price? The answer has to do with the elasticity of demand for CDs. Elasticity is one of those jargon terms that represents such a useful concept, you wish everyone knew about it. It simply means "how will people respond to a change in price?" If demand is inelastic, people won't change how much they buy if the price changes. If demand is elastic, people will buy lots more if the price falls, and lots less if the price rises.

We know labels have the power to set prices (unlike onion farmers) because CDs are priced considerably above marginal cost. How much above marginal costs depends on the elasticity of demand -- if demand is very elastic, then the price will be lower, if demand is very inelastic, that means price will be higher. Think about it this way, if someone's going to buy something no matter what, why not jack the price up on them? So a record label's price response to unauthorized copying depends on whether mp3s increase or decrease the elasticity of demand for CDs.

This is actually a tricky question. You could say that mp3s make demand more elastic, because now a CD needs to be really good otherwise I'll just substitute an mp3 for a CD (we might see this happen with albums that feature a single good song). This means labels should lower price. Or you could say mp3s make demand less elastic, because the only people left buying CDs will be those who *really* *really* value buying CDs and by definition, they respond less to changes in price. Examples of these folk could be older jazz and classical buyers, who don't like computers. In this case, labels should raise price. Or you could say that everyone substitutes equally from CDs to mp3s, meaning the elasticity is the same. In this case, price stays the same but labels will sell less, and make less money overall. Or you could argue that since mp3s promote CD purchases, file trading increases CD sales, meaning price stays the same but labels sell more, and make more money overall.

So which is it? (Or more realistically, which of the four possibilities is happening more?) According to the RIAA, between 2000 and 2001, quantities shipped dropped 10% and expenditure dropped 4% (meaning prices rose around 7%). This suggests that demand is becoming less elastic (price rises, quantity falls) but I haven't controlled the data for larger macroeconomic factors--so this isn't a firm conclusion.

Monday, December 02, 2002

iDrive a failure (and other pervasive thoughts)

I've been thinking a lot about pervasive computing recently, and it struck me that as computers appear in more and more everyday devices, they are entering market segments that have avoided computers to date, implying that these folks 1) don't think computers are all that useful and 2) have greater trouble learning how to use them. This means that pervasive technology is trying to get adopted by customers who have the lowest willingness to pay (because they see the smallest benefit) and highest cost (because training cost is part of the price too) of any technology buyer to date. Tough market to crack -- good customer experience will be key in driving adoption.

The Times has an article on how BMW's vaunted iDrive system is an utter failure -- it turns out that cramming 700 functions into a single joystick did not make anything easier to use. What a shock. But I'm sure the usability consultants on the project, Design Continuum will do better next time (watch out for the Flash animation on the way in). *Sigh*

And to bring the comments back to consumer segmentation, here's a Wired article musing about why Mac users are so fanatical. It talks about brands, cults, quality etc. etc., but I'd simply observe that everyone who doesn't care much switched to Windows, leaving just the most inelastic part of the demand curve behind.