ECON111 MICROECONOMIC PRINCIPLES
BACKGROUND AND QUESTION:
The arrival of Napster in 1999, followed by other (illegal) peer-to-peer (P2P) file-sharing technologies (e.g. Limewire, Kazaa, etc.), allowed internet users to illegally share unauthorised music and impacted the recorded music industry in a significant way. Sales of recorded music (CD albums and singles) fell dramatically and record labels began pursuing legal action against website services facilitating illegal P2P file sharing, as well as individuals caught infringing music copyright. Since this time, legal streaming services (such as Spotify and Apple Music) have entered the market and industry sales have started to recover but illegal downloading/streaming remains an important concern for the industry – particularly with the potential of block-chain technology to again disrupt the industry.
Using the basic demand and supply model as the foundation of your analysis, and importantly the concepts of consumer surplus and producer surplus, explain how the arrival of illegal P2P file-sharing technologies impacted the market for recorded music. In addition to relevant economic theories and concepts, you should also discuss some of the ethical issues that relate to illegal downloading.
You should structure your assignment around the following:
(i) Issues: Identify and explain the main economic and ethical issues related to the introduction of (illegal) P2P file-sharing technologies on the recorded music industry.
(ii) Analysis: Analyse the issues identified in (i). You must use relevant economic theory and ethical arguments.
(iii)Position: Derive your position on the issues identified in (i). You must provide evidence by interpreting, evaluating, integrating and synthesising your analysis done in (ii).
(iv) Critique: Defend your position derived in (iii) against the best possible argument(s) that may be raised in opposition to your position. You must consider the assumptions and implications of your position. (Hint: When considering consumer surplus, keep in mind consumers can derive surplus from both legal and illegal alternatives).
Ethical challenge and reduction in revenues in the music industry due to privacy and P2P sharing platforms.
The recorded music industry is an open perfect competition market, where the prices and sales of the product is majorly affected and determined by the demand and supply forces prevailing in the market.
With the arrival of Napster and other illegal Peer-to-peer file sharing platforms like Limewire, Kazaa etc., the demand, supply, profits and sales, everything was majorly affected as all these are interdependent.
Before Napster came in 1999, the revenues of the music industry was rising at an increasing scale and it went up to $13 billion (approx.), and after the entry of these illegal elements, the revenue of both the physical recorded music and digital sales of music decreased to $5.5 billion.
Let’s analyze each of the aspects via demand and supply functions.
The Demand Function : Demand of legal v/s illegal music
Demand of a product is defined by the quantity demanded of that product or service by the consumers in the market place.
Quantity demanded is the amount of product (in units) that the consumers are willing to purchase at a given price.
The demand function shows the relationship between the quantity demanded and the corresponding price factor affecting it. It is represented as-
Dx = f (Px, Pr, ....Y,T, F)
Where, Dx = Demand for the product
Px = price of the product
Pr = Price of related goods
T = tastes and preferences of the consumers
Y= Income of the buyers
Demand function states that the demand of a commodity has an inverse relationship with its price until the other factors are at status-quo, i.e. they are constant. It means that when price increases consumers tend to buy lesser quantity and vice-versa.
Note: All the factors apart from the price are called ‘other than price factors’. If any of these factors changes the demand function will cease to operate.
In the case of Napster and other illegal sources entering the industry, the demand of the goods (i.e. the music in digital as well as physical form) was increasing, but it was deviated towards the illegal sources rather than the legal ones.
Hence, production houses had to decrease the prices of the product to boost up the sales but even then the demand wasn’t going up in the same extent as the prices were coming down. This discouraged the music stores and other retail chains from keeping the records as they were suffering losses. Hence, the media and production houses couldn’t recover their investments they put into the artists and other technicians, to produce the mp3 audio as well as the video.
We can observe that there is decrease in price but there wasn’t an equal increase in the demand as per the demand function, this was because illegal sale of a product is an ‘other than price factor’ and because of that the demand function ceased to operate.
The Supply function
Supply of a product is defined by the quantity supplied by the producers of that product or service in the market place. Quantity supplied is the amount of product (in units) that the producers are willing to produce and sell in the market place at a given price, so as to make maximum profits. The supply function shows the relationship between the quantity supplied and the corresponding price prevailing in the market which he will charge for it. It is represented as-
Sx = f (Px, Pr, ….. t,T, S)
Where, Sx = Supply for the product
Px = price of the product
Pr = Price of related goods
t = Technological changes
T, S = taxes and subsidies
Supply function states that the supply of a commodity has an direct and positive relationship with its price until the other factors are at status-quo, i.e. they are constant. It means that when price increases producers are willing to produce and sell more quantity and vice-versa.
With the entry of Napster and other illegal sources entering the industry, the consumers were not willing to pay the prices the sellers were expecting from them. Even after reduction in the prices, the demand was not upto the mark. After a while the sale from the legal medium became almost stagnant as they couldn’t decrease the prices below a certain limit. The investment to produce a music album is huge and above that they were not getting any royalties from these websites and platforms who were using their art to make money for themselves. Again, in this situation the actual producers lost control over how much to charge and how much to sell because a factor ‘other than price’ was affecting both the quantity supplied as well the price charged for the product. Producers also tried studying the pattern, shifting from one genre to another, one country market to another country market, where they think there was less piracy, but none of them worked eventually.
Market equilibrium and Producer’s & Consumer’s Surplus
As we have discussed earlier, the prices in any free and competitive market is determined by the demand and supply forces. Hence, the market equilibrium is established where the demand and supply curves intersect, and the corresponding price becomes the equilibrium price.
There is a state of no profit and no loss at this point for the producer, i.e. this is the breakeven point. A breakeven price contains cost of production plus the normal profit for that product.But, this situation generally doesn’t happen in the real world. There is always either a consumer or a producer surplus at the equilibrium. A consumer surplus is created when the consumer pays lesser price for a product than what he was actually willing to pay.
Whereas, a producer surplus is created when a producer charges more price from the consumer than they are willing to pay, which means he is charging more than just the normal profit on a product.
In this case, it is very difficult to analyze it it’s a consumer surplus or not, because in the normal market with legal sales, the consumers were getting it at a lower price than what they were willing to pay because of lowering down of prices, but at the same time the consumers were facing a consumer deficit because even if prices were decreased, they could get it for a very less or almost negligible price from the illegal sources.
Whereas, the producer’s deficit was created in the legal market in either of the case because of the loss suffered by the production houses and the retailers. On the other hand, the illegal platforms made huge profits and enjoyed a surplus because they could charge least price as they didn’t incur any cost on the product.
In economic aspect, file sharing has emerged as a big challenge in the recording and music industry. It has decreased the effect of copyright on recorded music. Even after all the challenges, the supply of recorded music appears not to have fallen off much since Napster was shut down in 2002. Artists are now more into producing independent music , which operate with loer break-even thresholds, and focuses on maximum mass reach in the market.
In ethical aspect, even if there are prevalent illegal sources on the market to lure the consumers, there has been a lot of awareness on how unethical and discouraging it is for the artists and recording houses to see someone take an undue and unfair advantage of their hard work. Hence, now with YouTube and other legal platforms, the consumers are getting the records for free or very negligible prices. There are still people are willing to pay extra to buy the original copy of the physical record. This makes the artists and production houses to keep bringing new work in the market.
Having said that, more research, effective implementation of laws and mostly awareness among people is required to make the industry a safer place.