Since my post on price discrimination for newspapers has drawn some attention, a few people have responded with the argument that news online must inevitably be free because firms maximize profit by setting price equal to marginal cost.

And since the marginal cost of distributing one more unit of news through the internet is essentially zero, news should be free.

In my last post I looked almost exclusively at the demand side of the equation. This time I’ll look at the supply side a little bit.

Marginal cost pricing is not a trivial objection to charging for online news, and I used to be firmly in the “information wants to be free” camp. But something clearly seems wrong about that. Information is so valuable I just can’t imagine that it could all be free.

1. Infrastructure Costs

Marginal cost isn’t quite zero. Most estimates say that Google is losing hundreds of millions of dollars a year running YouTube. The IT infrastructure to run a complex or high traffic site costs a lot of money.

2. Pricing Power

Profit maximization only makes price equal marginal cost if firm’s don’t have pricing power. (i.e. they are in perfect competition). And while a lot of news content might be in perfect competition, most people still have strong preferences about which publications they do and do not like. By widening the gap in perceived quality and value, publications can make it easier and easier for themselves to charge for content.

3. Measuring the Wrong Thing

Most significantly, number of pageviews isn’t the right quantity to consider. The right quantity should be some abstract measure of how many pageviews can be attracted to the site. What’s the difference?

For most goods economists look at, the company can produce and sell identical copies and as long as they keep reducing the price, people will keep buying more to more and more people. With news articles, that’s not true. No matter how cheap an article about something someone don’t care about is, they won’t buy it. And no matter how cheap a second copy of a news article someone has already read is, they won’t buy it.

When someone makes the argument that the marginal cost of digital content is zero, they are thinking of the marginal cost of one more person reading the content, one more pageview of a website, or one more copy of a single piece of content being distributed.

But that’s not at all the supply side decision being made by media companies. A media company will decide how large a staff to hire, and that in turn will determine how much content is produced each day. Cost has labor as an input, and the marginal cost curve is the standard J-shaped curve.

In turn, the more content produced and the better that content is, the larger an audience can be attracted that will want to view it. The first pageview is easy to get, the millionth or the ten millionth is much harder and more expensive to get.

Instead of looking at the price of distributing one more copy of an article, we look at the price of creating content that will attract one more pageview. (Either more content, or better content – so that either more people will read, or the same people will read more)

All of a sudden marginal cost isn’t zero. But what significance does this have?

Marginal cost above zero means there’s hope for paid content online! Since content has value to consumers AND the cost of supplying content is not zero, the equilibrium price of content need not be zero either!

It also means that content companies need to lose their single-minded focus on expanding audience. To make money from paid content, growing an audience can’t come at the expense of the ability to price the product.

I’ve been kicking this last idea around in my head for quite a while and I’m still not sure that I’m thinking about it the right way. It’s certainly not as rigorous as it could be, and I haven’t tried to draw up some mock numbers with it to see if modelling things this way will work. In the fall, I’ll be starting to research this topic more rigorously for my senior thesis.