Piracy, losses for economy or redistribution of wealth?

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I haven’t made a blog post in a long while, because of lack of inspiration or whatever. However, I have one idea which I would like to share with the world, so it’s about time to write something.

During the entire SOPA/PIPA chaos, raids on Megaupload and everything else happening in the world recently I noticed something no one one pro-pirate side mentions. Champions of copyright monopolies and fascist laws like SOPA always remember to mention how some website, pirating of some movie or song make certain damage to the economy. It is very interesting that very few people take a notice to those accusations, partially probably because no one sane takes data like that seriously. What I will try to do in this article is to challenge claim that piracy makes damages to economy in grand scheme of things. What if piracy is simply redistribution of wealth in society? Or, what if because of it’s nature of unlimited resource piracy actually create surpluses? And why certain individuals and organizations don’t like that?

I will first go over some fairly simplified economic principles which I will later analytically add on with my views of claims about “economy losses” caused by piracy. Readers familiar with basic economic principles can skip first few paragraphs as there is not much new or interesting for them.

Supply and demand

So lets start with basics, with concept everyone can understand without much fuss and which is so natural – intersection of supply and demand curves:

Supply and demand

Supply and demand

On our graph, x-axis is labeled with Q and represents quantity of goods while y-axis is labeled with P and represents price of goods. Curve S is producer’s supply curve and it have positive slope because producers will for higher price always be ready to offer more goods. Curve D, which is consumer’s demand curve, have negative slope because when prices fall consumers will always want to buy more good on the market. Curves S and D intersect in point E and this is where market is in equilibrium with price P1 and quantity Q1.

In later text I will add to this basic model which represents market with perfect competition. This model is very abstract as it assumes, among else, completely free market and perfect information for all participants and those very hard to find in real life. Also, I won’t explain this and later graphs in much detail as I don’t want this article to get too long and I’m not writing it to familiarize people with basic principles of economy. Ones who want to know more can easily find plenty of data about these subjects of Google or Wikipedia.

Consumers’ and producers’ surplus

Now we come to one concept that is a little bit more complicated, but it is necessary to be completely understood it before reading rest of the article. This is concept of consumers’ and producers’ surplus.

Consumers’ surplus is monetary gain that consumers get because they are able to buy good for price lower than maximal price they would be ready to pay. For example, if you want to buy shoes and you are ready to part with 50€ for them but you buy them for 45€, those 5€ that remained in your pocket are your consumer’s surplus.

Producers’ surplus is each amount producers get for their product that is higher than minimal price they would be ready to sell their product for. In our example with shoes, if producer was willing to sell his shoes for 40€ and you bought them for 45€, he will also get producer’s surplus of 5€.

On graph, and on scope of entire market, surpluses look like this:

Consumers' and produces' surplus

Consumers' and produces' surplus

Surfaced labeled with number 1 is consumers’ surplus while surface labeled with number 2 is producers’ surplus. When market in in equilibrium marginal consumers whose maximal price is P1 and producers whose minimal price is P1 don’t achieve any surpluses while all other participants in the market do. Here lies importance of surpluses. If they are sum of surfaces 1 and 2 welfare of entire society is at maximum value. If surpluses are reduced for whatever reasons it is obvious that economic welfare of society will also be reduced. Reasons for reduction of surpluses are various, like taxes for example. However, taxes are inevitable and they also return to society via other channels, so their influence is debatable. What is much more important are imperfections of markets, namely various cases of monopolies.

Monopolies

Monopoly is situation when there is only one producer on the market. He is then able to set prices in a way to maximize his own profits, not paying too much attention of effect of his actions on entire society. For that reason quantity and price of goods on the market is not determined with intersection of curves of supply and demand but with intersection of monopolist’s curves of marginal revenue and marginal cost:

Monopoly

Monopoly

As we can see from the graph quantity of goods is determined with intersection of curves of marginal cost(MR) and marginal revenue(MR). On market without monopolist, MC curve would actually be supply curve. However, price on the market is not determined in intersection of MC and MR but with corresponding point for given quantity on demand curve(D).

It is obvious that price is higher and quantity lower than in model with perfect competition. Important question is, what happens with distribution of welfare and consumers’ and produces’ surpluses?

Consumers' and producers' surplus with monopoly.

Consumers' and producers' surplus with monopoly

It is obvious that distribution of wealth changes and it changes in favor of monopolist and on damage of consumers. Surface 1 is now considerably smaller than surface 2. But that’s not all. What about surface 3?

Surface 3 is called deadweight loss. Loss which is inflicted upon society with bare existence of monopolies and their high prices. From capitalist point of view problem of unequal distribution of wealth is much smaller than problem of deadweight loss generated by inefficiency of monopolies. Deadweight loss is irreversible loss of welfare for entire society and except with monopolies it also exists when market in affected by taxes, subventions, limited prices(both up and down) and when there are certain externalities.

Basic principles of economy 101 end here and most of stuff written below are some ideas and thoughts of mine. This economy crash course was necessary for understanding concept of deadweight loss and understanding of some my ideas later on.

Piracy and redistribution of wealth

First, let me return to my observation from the beginning of this article. Critics of free data sharing, or piracy how they call it, often claim that piracy inflict certain damages to the economy. The United States Justice Department, aware that they can’t write any drivel they want, announced that Megaupload is responsible for damages of about half billion US dollars to copyright owners. However, nothing can’t stop certain media and individuals to claim that damage is done to the entire economy not only copyright owners.

I will first try to use some common sense and leave some economical analysis for a bit later.

Of course, it is obvious piracy does some damages to copyright owners. Who is damaged more, real authors or middlemen in fancy suits with offices in high towers, is not subject of this article. To start, I will introduce extremely unrealistic assumption that anyone who download pirated song, video game or movie would actually buy that product if pirated version was unavailable to them.

Market with piracy is probably something like reversed monopoly. Actually, piracy is antithesis of monopoly. While monopolies artificially create scarcity, free share of information frees those resources. As monopolies generate deadweight losses, piracy also likely generate some kind of loses as market is not in the equilibrium, but piracy also generates something else. I will return there bit later.

One undisputed effect that piracy has is redistribution of wealth from hands of producers to hands of consumers. As we assumed that all consumers of pirated goods would buy original version with no other chose left, that means that producers’ surplus overflows to consumers’ surplus. Next implication is that consumers have more money in their pockets and that they will use that money to buy some other, likely impossible to pirate, goods. Conclusion is that losses of industries vulnerable to piracy are not money that simply vaporized but money that is indirectly redistributed to some other industries as result of more money available to consumers. It is possible that money went to other countries, but it most certainly haven’t disappeared. Even money that went in other countries can indirectly return via exports of industries not affected by piracy. It all comes to simple redistribution of wealth, and some people like that more than others, depending on side of distribution they are. It is only natural. And this is where my pure common sense critique of idea that piracy generates losses to economy ends and it is time for a little bit more advanced analysis.

But, none of this doesn’t have much sense, does it? Why? Because assumption that everyone who use pirated products would buy non-pirated ones with no other choice is idiotic at least. If that is correct, no rational economic individual would ever buy original products if same product can be found for free on some other place. Then again, huge amount of people still buy original products? How is that even possible? Follow me.

Piracy with an assumption that every individual is having rational economic behavior

I will again display graph with supply and demand curves in market with perfect competition:

Supply and demand

Supply and demand with perfect competition

This is obviously simple situation, and product in our example is not being pirated. We will assume that product in question is certain movie, distributed exclusively online and it is imaginatively called “The Movie”. Also, we will for now keep our assumption that with no piracy everyone buy original version and secondary implication of that assumption, that with piracy no one buy original version as that is all but rational economic behavior.

At some point a pirated version of “The Movie” is leaked online. In our model, following happens:

Absolute piracy

Absolute piracy

Pirated version of “The Movie” completely squeezed original one from the market. As digital copies are not scarce but unlimited resource supply is infinite, price is equal to zero and equilibrium is now at quantity Q2 when every last one of potential consumers is happy. Entire surface below demand curve is consumers’ surplus and producer of “The Movie” is out of business. Has something like this ever happened in real world? Of course not, and that can mean only one thing. Something stinks with our model.

Piracy in the real world

We now see something happening, something big, something that have never occurred in economic theory nor practice ever before. Monopolies on digital goods artificially crate scarce resource of something that is unlimited resource in its very nature. Unlimited because it can be multiplied infinite number of times. In simple model with supply and demand something like this can’t be represented. It is necessary to introduce one more curve, second supply curve, supply curve of pirated version of goods as unlimited resources.

Supply curve of pirated product

Supply curve of pirated product

Question is, what happens with demand for our “The Movie” now. Consumers have a choice between standard, original version of the “The Movie” as scarce resource and pirated version of “The Movie” as unlimited resource. Practice shows that one part of consumers will pick one and other part of consumers will pick other supply curve, depending on their preferences, no matter how irrational this behavior sounds.

In our example we will assume because of significant changes on the market with emergence of pirated version of “The Movie”, supply curve of original version shifted down and rotated a bit in counter-clockwise direction. This will have negative effect to producer of “The Movie” as he will lose some sales and price will also fall:

Equilibrium on the market with pirated version

Equilibrium on the market with pirated version

New equilibrium on the market of original product is in point E with price P3 and quantity Q3. However, we also have supply of pirated version of “The Movie”. From point Q3 and all the way until intersection of curves D and P we have consumers using pirated version of “The Movie”. Everyone who wanted to see “The Movie” did that. Part of consumer voluntarily paid price P3 to see “The Movie” while part downloaded pirated version. Now, what happens with surpluses?

Surpluses with piracy

Surpluses with piracy

It is clear that surfaces 1 and 2 are smaller that in situation without piracy. In absolute number consumer of original “The Movie” are on the loss, but their loss mainly comes from shift of demand curve. Individuals are not hit with loss as they will in our example certainly pay less for “The Movie” than before, but in absolute amount consumers’ surplus is lower. With fall of prices and quantity of sold original copies of “The Movie”, producers’ surplus is significantly smaller than before. Most important question here is, are gains of consumers bigger that losses of producers in the grand scheme of things?

Something new appears in our model with piracy – surface 3. It represents increase of consumers’ surplus caused by emergence of piracy and we will call it “pirates’ surplus”. Sum of surfaces 1, 2 and 3 is most certainly higher than sum of surfaces 1 and 2 in situation without piracy. What is the reason for this increase of surpluses and therefore welfare of entire society?

It happens because new, unlimited, resource is created and everyone who wants can have access to it. From analytical perspective, total welfare is increased significantly, but pirates’ surplus does not have same characteristics as classical consumers’ surplus. For those consumers who were prepared to buy “The Movie” at old price P1 but ended up using pirated version pirates’ surplus have the same characteristics as classical consumers’ surplus. But for those consumers who weren’t ready to pay P1 price, but became interested in “The Movie” when pirated version appeared, pirates’ surplus doesn’t simply represent more money in their pockets but general increase of their welfare for amount they attributed to original version of “The Movie” before piracy. Potential problem is because this is subjective value, very hard to measure on the market. Also, we don’t have redistribution of consumption towards other not-pirated products as a result of more money in the pockets. From that point of view, pirates’ surplus is not useful for welfare increase. However, something else happens and that is creation of new form of welfare, in the shape of value consumers unable to see “The Movie” before now got with pirated version.

The biggest with this newly created value, pirates’ surplus, is that it’s practically immeasurable. Similar like non-tradable goods(those are mostly goods that you create in your household for personal use). GDP and other welfare and income indicators won’t show pirates’ surplus as positive value, but it certainly exists through unmeasurable effects on individual and on culture of society as a whole.

Market reactions on piracy

Of course, market can react on piracy on many other ways, not only with shift of curve downwards and its rotation. Price of original good can go up or remain the same, losses of welfare can be huge and pirates’ surplus minor. There are many cases that I wont describe for now. If there are interest and good reactions on this article I will gladly try to expand this model and ideas in the future. Anyone who reads this texts is also welcomed to do so, and especially to point to eventual logical errors I made.

Finally, whole point of this article it to show that piracy is not simple stealing from the rich and giving to the poor, but liberation of artificially made scarce resource and its sharing to entire society. Piracy have some negative effects, that’s not a question. However, if my views in this article are correct, positive effects of piracy in most cases far exceed negatives.

To conclude, piracy is not stealing but sharing. Not only sharing of movies, music, video games of Windows copies, but in much larger scope sharing of knowledge, culture and everything else that makes us humans.

As all articles of this type before, this one also represent mine and only mine opinion and not much more than that, without many scientific facts. As if there are any bulletproof facts in the economy. All critics are welcome.

3 comments

  1. stewart kirk says:

    I fully agree with you. BTW are you still developing Rise of Men?

  2. Marko Mitrović says:

    Yes, I am kind of developing Rise of Men :)

    That means that I sadly haven’t done much of a note for too long period of time, but in about two-three weeks I will hopefuly be able to spend more time on it.

    Oh, and I will likely change the name of the game at some point, just need to think for something more nutral that sounds nice.

  3. MasterChen says:

    Excellent and intriguing. I’m going to share this article with my dad, master’s degree in economics. In sure he’ll find it interesting as well.

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