Abstract: The Economics of Open Source ====================================== Economics is the study of the production, distribution and consumption of resources and is distinct from the discipline of commerce. Whilst the study of commerce is concerned with maximising profit for the single organisation, economics is concerned with the most efficient aggregate result. From this basic distinction, the competing models of proprietary knowledge versus open source knowledge can be analysed initially according to the role of reflexive labour and then according to monopolistic versus competitive markets, comparative advantage, productivity, supply and demand equilibrium and elasticity, and finally the role of anti-trust legislation. Prosper Australia ----------------- Prosper Australia is a Victorian organisation that is over 100 years old. In the past it has been known as the Henry George League, after the famous land reformer and economist, and as Tax Reform Australia. The Scope of Economics Compared to Commerce -------------------------------------------- Economics is the study of human choice behaviour and how it effects the production, distribution, and consumption of scarce resources. Microeconomics is the branch of economics that studies how individual bodies make decisions to allocate limited resources. Macroeconomics is the branch that examines the behavior of the economy as a whole. Whilst whilst something may be commercially successful (e.g., a monopoly) and microeconomic theory can show how it acts as an incentive, both microeconomic and macroeconomic theory will describe the negative effects overall. Thus economics and commerce are different disciplines. Proprietory Versus Open Source Knowledge ---------------------------------------- Definition: open source describes practices in production and development that promote access to the end product's source materials--typically, their source code. "The future is open source everything." (Linus) Economists agree that open source products have a public goods aspect to them. The original work involves a great deal of expense; but the cost of reproducing the work (the marginal cost) is very low. Usually at this point, copyright is considered. This creates access costs on consumers who bear the access cost plus the administrative cost; copyright is a type of monopoly rent. A copyright restricts reproduction for a period of time at which point it passes into the public domain. A patent is a set of exclusive rights granted by a state to a patentee for a fixed period of time in exchange for the regulated, public disclosure of certain details of a device, method, process or composition of matter - anything known as an invention. A patent provides the right to exclude others from making, using, selling, offering for sale, or importing the patented invention for the term of the patent. A patent is a limited property right that the government offers to inventors in exchange for their agreement to share the details of their inventions with the public. Like any other property right, it may be sold, licensed, mortgaged, assigned or transferred, given away, or simply abandoned. Monopolies ---------- Being a monopoly is a good life. Many firms in a competitive marketplace wants to be a monopoly. In economics, a monopoly is defined as a persistent market situation where there is only one provider of a product or service. Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. * Single Sellers A pure monopoly is the sole provider of a good or the sole provider of a service. * No Close Substitutes The product or service is unique beyond brand identity, and cannot be easily replaced. * Price Maker In a pure monopoly a single firm controls the total supply of the whole industry and is able to exert a significant degree of control over the price, by changing the quantity supplied. * Blocked Entry Depending upon the form of the monopoly these barriers can be economic, technological, legal (patents, copyright), or of some other type of barrier that completely prevents other firms from entering the market. Price Setting ------------- In economics a company is said to have monopoly power if it faces a downward sloping demand curve. This is in contrast to a price taker that faces a horizontal demand curve. A price taker cannot choose the price that they sell at, since if they set it above the equilibrium price, they will sell none, and if they set it below the equilibrium price, they will have an infinite number of buyers (and be making less money than they could if they sold at the equilibrium price). In contrast, a business with monopoly power can choose the price they want to sell at. If they set it higher, they sell less. If they set it lower, they sell more. As long as the price elasticity of demand (in absolute value) for most customer is less than one, it is very advantageous to increase the price: the seller gets more money for less goods. With an increase of the price the price elasticity tends to rise, and in the optimum mentioned above it will for most customers be above one. A monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price. Example: Land Monopoly Competitive Markets ------------------- Most businesses are terrified of competition. Allocative efficiency occurs when price (P) is equal to marginal cost (MC), at which point the good is available to the consumer at the lowest possible price. Productive efficiency occurs when the firm produces at the lowest point on the average cost curve (AC), implying it cannot produce the goods any more cheaply. This would be achieved in perfect competition, since if a firm was not doing it another firm would be able to undercut it by selling products at a lower price. Patents ------- (Microeconomics) The economics surrounding a single patent, or group of patents, revolves around the balance between the expense of obtaining and maintaining the patent(s), and the income derived from owning that/those patents. (Macroeconomics) The patent system has an impact on the economy as a whole. The benefits of new research, once the research is publicly known, are available to the whole economy. Legal barriers to market entry; public franchise (exclusive right to provide a good or service), a government license (e.g., professional requirements), patents (exclusive right to a product or service). The claim is that patents protect inventors by preventing others from copying an invention until sufficient time has elaspsed for the inventor to reap benefits and therefore stimulate innovation by increasing the incentive to publicise inventions and offer them under license. But.... The longer a patent remains in force the more it *stifles* innovation. Further a patent improvement does not necessarily give the ability to produce the improvement ("suppressed inventions") Against Patents. ---------------- Bill Gates (Microsoft) 1991 Internal memo "If people had understood how patents would be granted when most of today's ideas were invented and had taken out patents, the industry would be at a complete standstill today...The solution is patenting as much as we can. A future startup with no patents of its own will be forced to pay whatever price the giants choose to impose. That price might be high. Established companies have an interest in excluding future competitors." Donald Knuth 2003 In a letter to the US Patent Office in 2003 "I strongly believe that the recent trend in patenting algorithms is of benefit only to a very small number of attorneys and inventors, while it is seriously harmful to the vast majority of people who want to do useful things with computers." "When I think of the computer programs I require daily to get my own work done, I cannot help but realize that none of them would exist today if software patents had been prevalent in the 1960s and 1970s. Changing the rules now will have the effect of freezing progress at essentially its current level." Benefits/Costs of Copyright/Patents ----------------------------------- Innovation Benefits * Creates an (monopolistic) incentive for research and new product development. * Encourages disclosure of inventions Costs * Impedes combination of new ideas and inventions * Provides an opportunity for rent-seeking Competition Benefits * Facilitates the entry of new (small) firms with a limited asset base or difficulties in obtaining finance Costs * Creates short-term monopolies, which may become long-term. Transaction Costs Benefits * Creates a neatly packaged negotiable IP right Costs * Creates patent risk uncertainty and/or search costs * Raises transaction costs for subsequent development Copyright --------- There are also some who continue to agree with copyright as a way to grant authors rights, but feel that it "outlives its welcome" by granting copyright for too long (eg, far beyond the lifetime of the author), and is therefore of little direct benefit to him or her. Copyright subsists for a variety of lengths in different jurisdictions and is increasing as the political strength of monopoly holders in copyright and patents increase. In most of the world the default length of copyright for many works is either life of the author plus 50 years, or plus 70 years. Even in more traditional forms such as prose, some authors, such as Cory Doctorow, retain the copyright to their work but license it for free distribution (for example under a Creative Commons licenses). This has the benefit of providing a structured scheme under which authors can loosen some of the barriers that copyright imposes on others, allowing them to partially contribute the work to the community (in the form of giving a general grant on copying, reproduction, use or adaptation subject to certain conditions) while retaining other exclusive rights they hold in it. Role of Antitrust Legislation and Alternatives ---------------------------------------------- Antitrust or competition laws are laws which prohibit anti-competitive behavior and unfair business practices. The laws make illegal certain practices deemed to hurt businesses or consumers or both, or generally to violate standards of ethical behavior. Government agencies known as competition regulators regulate antitrust laws, and may also be responsible for regulating related laws dealing with consumer protection. A business with a monopoly over certain products or services may be in violation of antitrust laws if it has abused its dominant position or market power. Although not all anti-competitive behavior which is subject to antitrust laws involve illegal cartels or trusts, the following types of activity are generally prohibited. * Bid rigging - A form of price fixing and market allocation, and involves an agreement in which one party of a group of bidders will be designated to win the bid. * Predatory pricing - The practice of a firm selling a product at very low price with the intent of driving competitors out of the market, or create a barrier to entry into the market for potential new competitors. * Price fixing - An agreement between business competitors selling the same product or service on its price. * Tying - The practice of making the sale of one good conditional on the purchase of a second good. * Vendor lock-in - Is a situation in which a customer is so dependent on a vendor for products and services that he or she cannot move to another vendor without substantial switching costs. The plaintiffs alleged that Microsoft abused monopoly power in its handling of operating system sales and web browser sales. Bundling MS-Windows and IE together is alleged to have been responsible for Microsoft's victory in the browser wars as every Windows user had a copy of Internet Explorer. Underlying these disputes were questions over whether Microsoft altered or manipulated its application programming interfaces (APIs) to favor Internet Explorer over third party web browsers, Microsoft's conduct in forming restrictive licensing agreements with OEM computer manufacturers. The Alternative: Henry George was highly critical of restrictive patents and copyrights. George advocated replacement of patents with government supported incentives for invention and scientific investigation and dismantling of monopolies when possible. This idea, which retains author and inventor incentives yet removes monopolistic power, is undeveloped, requires further elaboration and is increasingly important.