Sunday Aug 30, 2009

Free, the right price for software

Economic systems are about how to use scarce resources and the Price Mechanism is the way in which a optimal resource allocation occurs. Economists use a branch of theory called “Welfare Economics” to analyse and model the efficiency of the productive economy, and a theoretically maximally efficient set of states can be defined within a model, known as the Pareto-efficiency frontier. A perfectly competitive market meets the efficiency requirements, imperfect or distorted markets do not. Distortions can be caused by the existence of monopolistic markets, taxation, externalities or missing markets.

Traditional Welfare economics rarely considers how copyright and patent law create barriers to entry to markets and thus husband the growth of monopolistic markets, where supply is restricted and prices driven up. It needs to be born in mind that overpricing products such as software which are inputs to the economic process as well as output, means that some otherwise efficient goods will not be produced; they cost too much.

It should also be born in mind that the majority of the world's software is not licensed or charged for, although much of this free to use software is not traded at all, remaining the proprietary goods of their owners who use them to produce other goods and/or services. Benkler in his book, “the Wealth of Networks”, suggests there are nine business models for pursuing value in software, of which only three of them involve trading rights i.e. charging for software. If there was no software copyright i.e. copying was legal and free the only price, software would still be written. The overpricing of software distorts both today's market and the innovation creating tomorrow's. The price mechanism should ensure that resources that are scarce and consumed should be payed for. Software is not scarce, although the people that write it and the machines that run it are. Resources such as software should be free.

This was meant to be an essay based on some slides I have been trailing inside the company, but I discovered how hard it is and how much time it takes to actually put ideas into essay form while preparing the paper behind what became Monopoly & Prices, see below. So this is more of an abstract, I shall upload the essay when finished to my personal site downloads page.

Thanks once again to Beggs, Fischer and Dornbusch, whose Economics 8th Edition reminded me of my Welfare Economics.

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Wednesday Aug 26, 2009

Monopoly and prices

Monopolies restrict supply and offer their goods at prices above equilibrium price, the opportunity cost of the resources used to make the goods. I am writing a short paper about this since it is a piece of thinking I revisited while developing my thoughts on free software, but is not central to those thoughts. There remain those who still think that monopolistic domination of markets is a legitimate business goal and that public policy and regulation should not inhibit this "free" market tendency. A review of the theory of the firm shows that monopolies restrict supply, raise prices and make super-profits.

Firms seek to maximise profit. As prices fall, demand increases. As output increases, average costs fall and then may rise due to economies of scale and then diminishing returns. In a "perfect" market, all firms are price takers. Business failure means that expensive suppliers leave the market, and super-profits caused by the difference in a given price and superior cost structures of the survivors encourage new entrants to bid down the price. In a perfect market, there are no super-profits and prices are equal to average costs. In a monopolistic or imperfect market, defined as where a firm's output decisions affect price, a firm's maximum profit occurs where its marginal cost is equal to its marginal revenue. No matter if dis-economies of scale are trivial or important, this will always be a lower output and a higher price than the opportunity cost price/output position.

I am writing a longer essay about this, which I hope to post on this blog, but I shall mirror it on my personal site downloads page. I doubt that there's anything original in the essay, but having it one place is useful to me and it'll help me write my essay/presentation that I promised Dominc Kay on "Why free is the right price for software?".

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DaveLevy

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