Wednesday, February 26, 2003

The Economics of Music-Ben's post on the Grammies and a pair of microeconomic classes got me thinking of the economics of the music industry and why album prices are so high. Here's the part of Ben's piece that got the brain working
But the point is, films are not released in an artificial market. If an indie-level film (Blair Witch) or even a foreign film (Crouching Tiger) gets good word of mouth, it can pick up distribution and spread around the country, and get nominated for Oscars, and make tons of cash. There is nothing preventing that film from getting picked up by theater chains, or short of that, getting bought by HBO. Success is not a certainty, even for expensive and heavily promoted films. And success is a possibility for crowd-pleasing low-budget flicks. It's called the free market. The Music Industry, on the other hand, is not a free market at all. It's a back-scratching socialist economy. The radio stations play only select groups of songs, bought from labels, both of which simultaneously owned by companies that also happen to own concert venues and ticketselling groups. People don't hear the musical equivalent of indie films or low-budget flicks, because they can't. They can't drive into the city to see a different show. And music has a much more difficult time of gaining word-of-mouth momentum outside of local limits. It's called the socialist economy.
Well, more like a combination of monopolistic competition and oligopoly. The market for individual albums look a bit like monopolistic competition, where you have a number of different products that are unique but with close substitutes. The pricing power in monopolistic competition depends on how inelastic the demand for the product is, and I think that the demand for a particular album is fairly inelastic (demand goes down less than prices go up). If you're going in for Norah Jones' album, you're likely to buy it whether it's priced at $12.99 or $16.99. The availability of substitutes effects inelasticity, and the more unique an album is, the more inelastic the demand for it will be; putting Sade on special for $9.99 won't reduce the demand for Norah Jones much. When demand's inelastic, companies make money by raising prices; as long as the demand goes down by a smaller percentage than the price went up by, they're better off raising prices. With a fairly unique product with less-than-perfect substitutes, it's in a record company's best interest to keep prices high. This is compounded by the problem of oligopoly pricing; expect something on Nash Equilibrium this weekend as I prep for covering it in my Managerial Econ class. When you have a small number of dominant suppliers, it's not in their collective interest to get into a price war. Even absent organized price-fixing, an oligopoly will tend to see higher prices, as no one wants to start a price war that will eventually cut into everyone's profits. The dominance of the big labels in placement on radio stations make sure to turn most commercial radio stations into infomercials for the big label's artists, thus artificially boosting supply for their product. Even Christian music has a similar effect, with a few major labels leading the market. The way to break through that clutter is to have programmers at stations that are willing to listen to independent labels; it's easier to listen to the latest releases that the big boys drop in your lap than to wade through some quirky stuff, especially when the big label PR machine will crank up demand for their stuff. Truly great radio stations have DJs and programmers who do their homework, but it's a lot easier to choose from what the major labels drop on your lap. This might be especially true for the more corporate stations, who make a national playlist and have people play one song from list A, then one song from list B, then one song from list C.... The Internet might be a way around some of the corporatization of radio; small, quirky stations can simulcast on the Web and gain national and international listeners. When we get to a point of inexpensive wireless Internet, we might start to see such stations end-run the paint-by-numbers DJs and start to give small-label artists a better hearing.

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