Digital Goods Bargaining: A Folk Theorem

This paper develops a theoretical model for the dynamic bargaining of digital goods that incorporates two fundamental characteristics: free disposability on the buyer side and zero marginal cost on the seller side. We show that when both parties are sufficiently patient, the seller's equilibrium payoffs can span a continuum from the lowest buyer valuation up to approximately the static monopoly commitment payoff, subject to the constraint that the lowest-type buyer receives an efficient allocation. The key reason is that free disposability and zero marginal cost make the off-path threat of selling the highest-quality version at the lowest price credible, thereby allowing the seller to sustain more profitable reputational equilibria. Our findings help rationalize empirical evidence of high profits in digital industries and demonstrate how the fundamental characteristics of digital goods generate new reputational effects in a dynamic bargaining setting.