Infinity Is Your Friend In Economics

from the use-it-wisely dept

Continuing our ongoing series looking at economics when scarcity is removed from markets, I wanted to go back to the early discussion on the importance of understanding zero in making sense of markets where scarcity is removed. That post discussed how many who believe economics requires scarcity do so because they believe economic equations break down when a zero is put into them. That is, they see a zero in the "marginal cost = price" statement and they say that the system must be broken, because you can't have a market when the price is zero. However, that's wrong. Zero works just fine, but you have to understand why.

The key actually isn't in zero, but zero's flip side: infinity. Just like many early societies had tremendous difficulty in coming to understand the concept of zero, the concept of infinity was incredibly difficult to grasp. Just as with zero, certain aspects of mathematics and physics stalled out without an understanding of infinity -- and it would be a shame if the same happens for economics. However, just as with zero, many who look at the economics get scared off by infinity and assume it must break otherwise proven concepts. Throw an infinity into the supply of a good and the supply/demand curve is going to toss out a price of zero (sounds familiar, right?). Again, the first assumption is to assume the system is broken and to look for ways to artificially limit supply.

However, the mistake here is to look at the market in a manner that is way too simplified. Markets aren't just dynamic things that constantly change, but they also impact other markets. Any good that is a component of another good may be a finished good for the seller, but for the buyer it's a resource that has a cost. The more costly that resource is, the more expensive it is to make that other good. The impact flows throughout the economy. If the inputs get cheaper, that makes the finished goods cheaper, which open up more opportunities for greater economic development. That means that even if you have an infinite good in one market, not all the markets it touches on are also infinite. However, the infinite good suddenly becomes a really useful and cheap resource in all those other markets.

So the trick to embracing infinite goods isn't in limiting the infinite nature of them, but in rethinking how you view them. Instead of looking at them as goods to sell, look at them as inputs into something else. In other words, rather than thinking of them as a product the market is pressuring you to price at $0, recognize they're an infinite resource that is available for you to use freely in other products and markets. When looked at that way, the infinite nature of the goods is no longer a problem, but a tremendous resource to be exploited. It almost becomes difficult to believe that people would actively try to limit an infinitely exploitable resource, but they do so because they don't understand infinity and don't look at the good as a resource.

If you're looking to catch up on the posts in the series, I've listed them out below:

Economics Of Abundance Getting Some Well Deserved Attention
The Importance Of Zero In Destroying The Scarcity Myth Of Economics
The Economics Of Abundance Is Not A Moral Issue
A Lack Of Scarcity Has (Almost) Nothing To Do With Piracy
A Lack Of Scarcity Feeds The Long Tail By Increasing The Pie
Why The Lack Of Scarcity In Economics Is Getting More Important Now
History Repeats Itself: How The RIAA Is Like 17th Century French Button-Makers
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  1. identicon
    Joe Emenaker, 18 Jan 2007 @ 5:48pm

    I don't agree...

    I might be misunderstanding your point... but I don't agree that marginal-cost=0 means that the current economic models break down.

    See, in high school, they teach you about the demand curve and the supply curve and they tell you about how the equilibrium price is where the two curves cross. How quaint. What they don't tell you (or, they didn't tell *me* anyway) is that this isn't the price that a supplier is really going to charge. The equilibrium price is merely the price at which there will be no surplus and no shortage. But that's not the price you see in the store.

    The concept of marginal-cost=0 is great at illustrating this. With marginal-cost=0, your supply curve is going to be off the chart; you'll be willing to supply infinite quantities at all prices. In this case, the supply and demand curves *never* intersect. There's no price for the item that will result in no surplus.

    So what governs the price that we see in the stores? Maximizing revenue (well, "profit", actually... but they're the same in marginal-cost=0 economics, anyway). To maximize revenue, you don't need the supply curve.... just the demand curve. For any price/quantity point on the demand curve, the total revenue is the price *multiplied* by the quantity. It's the area of a rectangle with opposite corners at (0,0) and at the chosen point on the demand curve. You want to maximize that area to maximize revenue. At the extreme ends of the curve, the rectangle becomes very thin (as you either sell a bunch of widgets for almost nothing, or 1 widget for a lot). Yet, somewhere in the middle, the area will be at a maximum... and that's where you want to set your price. (It turns out that the practice of "price discrimination", which seeks to get more money for the item from only those people who are willing to pay more, is an attempt to get the *entire* area underneath the demand curve, and not just the area of a rectangle under it).

    So, your assertion that marginal-cost=0 upsets the current system doesn't ring true with me, since pricing is about maximizing revenue, not eliminating surplus/shortage.

    As an additional example, look at movie studios. Movies are the quintessential example of something where the fixed cost vastly outweighs the marginal costs... even before the digital age. The $100,000,000 to make "Titanic" exceeds, probably by an order of 1,000, the cost of printing/shipping the reels of film to all of the movie theaters that showed it. So, for movie studios, the marginal cost is negligible.... yet it isn't free to go to the movies.

    So, the movie studios deal with this zero-marginal-cost economics all the time. The whole reason they invested $100M into "Titanic" is because they looked just at the *demand* curve and figured out how much money they expected to rake in from it.

    Also, keep in mind that zero-marginal-cost doesn't mean that it's the end of scarcity. The scarcity lies in the production of the original item. In traditional economics, we compete with our dollars *against* other consumers like ourselves *over* a scarcity of quantity of an item. With zero-marginal-cost economics, we compete *against* the other things the creator could be producing *over* whether that item is even initially created.

    As an example, suppose that Eminem is thinking of going into the studio and recording a new album.... or... he might, instead, design a new mousetrap. Under the "zero-marginal-cost means scarcity doesn't exist" notion, the album should be free, Eminem won't make any money, and so he'll just decide to go work on mousetraps and then, suddenly, there's *total* scarcity.

    Now... you don't like the record companies and movie studios. I get that. I don't like them, either. But I think that you're misrepresenting the economics of the issue in order to make your case against the way they're behaving these days.

    The record companies are behaving they way they are for two reasons. First is because they think they're losing revenue. Everybody knows that one. The other reason is because they're under threat from one of the largest effects of the internet: disintermediation. Disintermediation is the process of removing intermediaries or, in plain English, "getting rid of the middle-man".

    With music, record companies are intermediaries that have placed themselves between the artist and the listener, and they will oppose any effort or trend toward a system that doesn't keep them in the process... even ones in which piracy were eliminated and every artist got their full share of royalties.

    Think about that for a moment. The arguments that the RIAA uses against music downloading are that the piracy is causing the poor artists to lose income. Yet, when you imagine it, you realize that a system where all listeners paid artists directly (where piracy were eliminated and the artists were making their full share) would be opposed by the RIAA. That's when you realize that the things that the RIAA says it's worried about are *not* what it's worried about. The RIAA is worried about the RIAA maintaining it's prominence in an age when it's looking more and more like a dinosaur.

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