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Managing Digital Piracy: Pricing, Protection and Welfare

  • Arun Sundararajan

    (New York University)

This paper analyzes the optimal choice of pricing schedules and technological deterrence levels in a market with digital piracy, when legal sellers can sometimes control the extent of piracy by implementing digital rights management (DRM) systems. It is shown that the seller's optimal pricing schedule can be characterized as a simple combination of the zero-piracy pricing schedule, and a piracy-indifferent pricing schedule which makes all customers indifferent between legal consumption and piracy. An increase in the level of piracy is shown to lower prices and profits, but may improve welfare by expanding the fraction of legal users and the volume of legal usage. In the absence of price- discrimination, the optimal level of technology-based protection against piracy is shown to be the technologically-maximal level, which maximizes the difference between the quality of the legal and pirated goods. However, when a seller can price-discriminate, it is always optimal for them to choose a strictly lower level of technology-based protection. Moreover, if a DRM system weakens over time, due to its technology being progressively hacked, the optimal strategic response may involve either increasing or decreasing the level of technology-based protection and the corresponding prices. This direction of change is related to whether the technology implementing each marginal reduction in piracy is increasingly less or more vulnerable to hacking. Pricing and technology choice guidelines based on these results are presented, some social welfare issues are discussed, and ongoing work on the role of usage externalities in pricing and protection is outlined

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Paper provided by EconWPA in its series Law and Economics with number 0307001.

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Length: 40 pages
Date of creation: 22 Jul 2003
Date of revision:
Handle: RePEc:wpa:wuwple:0307001
Note: Type of Document - PDF; prepared on Windows NT; pages: 40 ; figures: included
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  1. Arun Sundararajan, 2003. "Network Effects, Nonlinear Pricing and Entry Deterrence," Industrial Organization 0307002, EconWPA.
  2. Fernando Nascimento & Wilfried R. Vanhonacker, 1988. "Optimal Strategic Pricing of Reproducible Consumer Products," Management Science, INFORMS, vol. 34(8), pages 921-937, August.
  3. Johnson, William R, 1985. "The Economics of Copying," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 158-74, February.
  4. M. Alvisi & E. Argentesi & E. Carbonara, 2002. "Piracy and Quality Choice in Monopolistic Markets," Working Papers 436, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Takeyama, Lisa N, 1994. "The Welfare Implications of Unauthorized Reproduction of Intellectual Property in the Presence of Demand Network Externalities," Journal of Industrial Economics, Wiley Blackwell, vol. 42(2), pages 155-66, June.
  6. Yoon, Kiho, 2002. "The optimal level of copyright protection," Information Economics and Policy, Elsevier, vol. 14(3), pages 327-348, September.
  7. Arun Sundararajan, 2003. "Nonlinear pricing of information goods," Industrial Organization 0307003, EconWPA.
  8. Arun Sundararajan, 2003. "Network Effects, Nonlinear Pricing and Entry Deterrence," Working Papers 03-17, New York University, Leonard N. Stern School of Business, Department of Economics.
  9. Liebowitz, S J, 1985. "Copying and Indirect Appropriability: Photocopying of Journals," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 945-57, October.
  10. Kathleen Reavis Conner & Richard P. Rumelt, 1991. "Software Piracy: An Analysis of Protection Strategies," Management Science, INFORMS, vol. 37(2), pages 125-139, February.
  11. Stanley M. Besen & Leo J. Raskind, 1991. "An Introduction to the Law and Economics of Intellectual Property," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 3-27, Winter.
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