Even if intellectual property rights are highly effective, there are some information products that will not be produced, because of the problem of high fixed costs. This can best be illustrated by a diagram.
Figure 3 shows the total cost (the hyperbola TC, in red), the marginal cost (the horizontal line MC, also in red) and the demand (line D, in blue) for a hypothetical information good. The total cost is the sum of a fixed cost, the cost of production of the information product, and a variable cost, the cost of producing the medium and coding of the information product in the medium. For example, the information product might be a multimedia compilation, and the medium CD ROM. Then the fixed cost is the cost of creating the multimedia compilation and the variable cost is the cost of producing (and distributing) the CD ROM disks with the code for the compilation. The marginal cost is the cost of producing one more CD ROM. We are assuming that this marginal cost is constant, so that the cost of production of the encoded medium is just MC times the number of CD ROM disks produced. In the diagram, the difference between MC and TC is the same as the fixed cost of producing the information product divided by the number of units (CD ROM disks in the example) produced. The fixed cost per unit of output declines toward zero as the output increases and thus TC declines toward MC.
The price that consumers are willing to pay varies with the amount offered, as shown by the demand line D. We note that there is no output at which the price will cover the average total cost of the information product and medium. Now, suppose nevertheless that the information product is produced and sold at the marginal cost, M. Of course, the producers of the information product will not cover their costs. Indeed they will lose an amount measured by the rectangle TzyM. However, the consumers gain a consumers' surplus measured by the area of the triangle vyM. We can easily see that the consumers' gain is greater than the producers' loss. The loss rectangle and the gain triangle have area TxyM in common, so we need compare only the areas of triangles xzy and vxT. Triangle vxT being larger than xzy, the consumers' gain is greater than the producers' loss from the production of the production of the information product.
The difficulty is that although the consumers benefit more than the producers lose, the producers have great difficulty in getting the consumers to bear the cost. Raising the price won't do it, because of the slippery slope problem: every time the producer raises the price, the amount sold drops off enough to leave the producer still taking a loss. Price discrimination might be helpful. Some public utilities, such as electric power and telephone companies, face similar problems. Historically, these public utilities have solved the problem partly by charging people according to how much (or which) services they use. But price discrimination is not likely to be as effective in a case such as this -- those who get a volume discount for their purchases of CD ROM disks can resell them, competing with the producer for the customers who have to pay the higher price.
Thus, some information products that give an excess of consumer benefits over total costs will nevertheless not be profitable to produce, even when intellectual property rights are perfectly enforced. It should be stressed that not all unprofitable information products will pass this cost-benefit test! There are at least three categories: products that pass both the profit test and the cost-benefit test, products that fail both tests, and products that pass the cost-benefit test but fail the profit test, as in this example. The third is probably the smallest category, but it is the problematic one, since it provides another case in which markets fail to provide an incentive to the efficient supply of information products.
Summary on Intellectual Property
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