REVIEW FOR MIDTERM EXAM

ECONOMIC ISSUES IN THE MUSIC INDUSTRY

ECON 4720

STRUCTURE, CONDUCT, PERFORMANCEStructure Conduct Performance

Concentration Pricing Profitability

Product Differentiation Advertising Efficiency

Substitutability Research & Development

Deadweight Loss

Entry Conditions Coordination vs. Rivalry

Product Variety

Growth or Decline Technical Progress

STRUCTUREConcentration

• Herfindahl-Hirschman Index or HHI• HHI = = sum of squared market shares• HHI > 2000 considered “high”• HHI declined until about 1960, then increased

• Magnetic tape for recording encouraged entry• Economies of scale in distribution encouraged mergers• As of 2012, only 3 major labels: Sony, Universal, Warner

• HHI likely > 2200 today

Entry Conditions

• Costs have declined due to computer software and hardware and the Internet

• barriers to entry have declined since 1990

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 EVIDENCEPricing

• Real Prices peak in 1982, then decline• Real Prices rose 1998-2005 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)(Qc-Q1)

• Lerner Index: (P-MC)/P = -(1/Ep) 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 = aRk

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 TAILIncrease 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 SHARINGIndustry 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 ISSUESCurrent 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. 1999• 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

• PVT*(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