REVIEW FOR MIDTERM EXAM ECONOMIC ISSUES IN THE MUSIC INDUSTRY ECON 4720

STRUCTURE, CONDUCT, PERFORMANCE StructureConductPerformance ConcentrationPricingProfitability Product DifferentiationAdvertisingEfficiency SubstitutabilityResearch & Development Deadweight Loss Entry ConditionsCoordination vs. Rivalry Product Variety Growth or DeclineTechnical Progress

STRUCTURE

CONDUCT Models Monopolistic Competition (graph) Falling costs increase Q, P falls, profits increase Profits attract entry, firms (products/titles) increase Zero Economic Profit in Long Run Bertrand with differentiated products Falling costs cause falling P, Q increases, profits rise Entry may be attracted; if so, P approaches MC

CONDUCT EVIDENCE Pricing Real Prices peak in 1982, then decline Real Prices rose as file sharing grew Then fell again Quality and variety may have increased Chart turnover has risen steadily since 1990 Cooperation Major labels accused of resale price maintenance in 1990’s (denied marketing allowances to price cutting retailers), but may have been an inventory strategy Entry Deterrence Large up-front payments required of streaming services Alleged to have made services unprofitable May have been efficient scheme to avoid double mark-ups (graph)

PERFORMANCE Efficiency P = MC maximizes Economic Surplus P > MC, deadweight loss in Economic Surplus Profits are unreliable measure of efficiency Data availability High profit consistent with both efficiency and monopoly behavior Zero economic profit can result with a DWL DWL = ½(P-MC)(Q c -Q 1 ) Lerner Index: (P-MC)/P = -(1/E p ) at π-max P & Q DWL = ½(PQ)(-Ep) [(P-MC)/P] 2 = ½ PQ[(P-MC)/P]

PERFORMANCE DWL may have declined in Digital Age Falling costs and prices reduce DWL Revenue sharing (as for iTunes) may also reduce DWL (graph) File sharing reduces DWL as long as works are produced Product Variety Variety and quality may have increased since 1999 Progressivity Numerous new product categories available Despite opposition or grudging support from major labels

THE SUPERSTAR PHENOMENON Characterized by Concentration of output among a few individuals Skewed distribution of income Very large rewards at the top Requirements (graph) Imperfect substitutability (differentiated products) Economies of scale Access to a market of large or increasing scope Usually caused by technological change

SUPERSTARS Decline of superstars in the digital age Decreasing cost of recording and distribution Increased entry of new artists/titles Increased access of consumers to new performers by way of the Internet Easy access of new entrants to mass market Facilitated by Social media Search engines

THE LONG TAIL AND INTERNET RETAILING Power law market: S = aR k Internet expands markets for retailers allowing almost unlimited inventory Requires Variety/inequality (imperfect substitutes) Network effects to amplify differences (access to mass market) Add economies of scale and these are the same as for superstars The Long Tail is the same as the Superstar effect for Internet retailers

THE LONG TAIL Increase in market scope and economies of scale allow Internet retailers to hold larger inventories of titles and account for a larger share of sales Traditional retailers Big Box stores carry about 4,500 titles Specialty retailers may carry 30,000 titles Internet retailers physical retailers (Amazon) carry 500,000 titles digital retailers (iTunes, Spotify) carry almost unlimited inventory Influences Increasing market scope and network effects Increased “innovation” among consumers Niche titles’ sales increase relative to superstars or “hits”

DIGITAL PIRACY AND FILE SHARING Industry view (RIAA) Piracy is cause of sales decline – more so for “hits” P2P accounts for only 18% of music acquisition Contrary View Sales decline due to piracy is small, when other factors are accounted for File sharers spend more on music than non-sharers Listening to music samples online – legal or illegal - may prompt more music purchases Modeling Piracy (graphs) Some consumers never pirate Some pirate more or less depending on price Some always pirate Suggests an opportunity to price discriminate: downloads vs. physical sales

COPYRIGHT ISSUES Current term of copyright is 70 years after death of the author Orphaned works – owners cannot be found “Fair use” allows copying for personal use, but status of copying digital files is in dispute File sharing started by Napster in June, 1999 RIAA sues for copyright infringement in Dec Napster grows rapidly for next 18 months Napster shuts down in July 2001 RIAA suits against new file sharing sites are dismissed RIAA begins suing individual file sharers in 2003 $100 million on lawsuits yields few damages and little effect RIAA now targeting search engines and Internet providers to block access to offending services

OPTIMAL COPYRIGHT TERM Copyrights create monopolies (graphs) DWL over life of copyright Maximum Economic Surplus at expiration Optimal Copyright Term (graph) Minimizes term of monopoly DWL consistent with production of the work This occurs when the term, T, is set so that the present value of producer surplus during the monopoly period is just equal to the fixed cost of producing the work PV T* (PS) = FC

IS COPYRIGHT TERM TOO LONG? Longer term may be justified if (graph) Many new works result from increasing term Such that Economic Surplus increases Or if investments in copyrighted works improve their value Who benefits from longer terms? Any benefit to artists is far in future and uncertain Consumers benefit only if many more works are created Long-lived owners (corporations) of existing works, especially “hits” whose rights are soon to expire, benefit almost immediately Why not treat copyright like a patent with 20 year term? Patented innovations may become obsolete over time Some creative works are not appreciated immediately