Artificial scarcity/non-rival

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About

Artificial scarcity of non-rival resources – most commonly those referred to as intellectual property – is usually created as a by-product of rent-seeking [W], i.e. efforts to extract revenue from the (essentially cost-less) process of distribution.

While this solution is very sub-optimal and causes further severe problems, it is one workable (if possibly not sustainable) solution to the problem of funding production of non-rival resources.[1]

Example: Software

A common usage of artificial scarcity in this context is proprietary, or closed-source, computer software. Any software application can be easily duplicated billions of times over for a relatively cheap production price (an initial investment in a computer, an internet connection, and any power consumption costs; and these are already fixed costs in most environments). On the margin, the price of copying software is next to nothing, costing only a small amount of power and a fraction of a second. Things like serial numbers, license agreements, and intellectual property laws create artificial scarcity, and give monetary value to otherwise free copies.

Technocrats argue that if the price system were removed, there would be no personal incentive to artificially create scarcity in products, and thus something similar to the open source model of distribution would dominate – but it is not clear how the cost of production can be met reliably, absent some fundamental social changes such as a ubiquitous income, although other methods have been used with some success.

Example: Drugs

Production of drugs is fairly cheap to execute on a large scale, but new drugs are very expensive. This is because the initial investment to develop a drug is generally billions of dollars, due to a number of factors including strict consumer safety regulations. Typically drug companies have profit margins much higher than this initial investment, but the high payoff also attracts many companies to compete, increasing the pace of drug development.

The current solution to this is usually to create an exclusive, time-limited right for the drug developer to sell the drug -- a patent -- in order to allow the developer to recoup the initial investment via sales revenue. After a set number of years enjoying an artificial scarcity, the patent expires and cheap generic versions of the drug enter the market. Thus, the drug developer gets a return on investment, and competition is used to lower prices later on.

Mechanisms

Production possibilities frontier of showing trade-off.

With nearly all goods, a trade-off occurs when decisions are made about production. The graph shows the economic anomaly that occurs with artificially scarce products. Because (for example) leather boots consume resources, a trade-off is noticed between running shoes and boots; i.e. in order to produce more boots one has to produce fewer running shoes because of limited resources. This trade-off is illustrated by a move from P1 to P2 in the Production Possibilities graph on the left.

With computer software, no significant trade-off occurs. To produce more of a certain piece of digital information, since virtually no resources are used to copy the information there is no trade-off with the production of other things, like shoes and boots. In essence, problems of artificial scarcity usually arise when a good that was once scarce becomes abundant due to extreme increases in productivity and technology.[2]

If you have an apple and I have an apple and we exchange apples then you and I will still each have one apple. But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas.

—Phi Kappa Phi Journal[3]

Alternatives

One alternative would be simply to universally drop all attempts at generating revenue from sales of non-rival goods. While this would cause a revenue reduction due to the loss in sales, this would be more than made up for by the gain created by freeing up the use of non-rival goods from all sources.

Unfortunately, this mechanism is of limited utility from a business perspective as any business that began developing software that was freely available for its competitors would be at a competitive disadvantage due to the fact that all would benefit but all of the costs would be borne by the business which paid for the development.

A more workable model seems to be the sharing of work on large projects across multiple companies. In this way, no single company bears the costs, and all gain the benefits of external labor (often unpaid), made possible by providing free access to the source code. This model is responsible for a large and growing body of highly effective open source software, including the database and wiki engines used by Wikipedia and Issuepedia.

That model, however, has not worked well for entertainment software (games), since there is no productivity gain to drive corporate participation.

Related

  • The tendency of profit-driven producers to obstruct distribution in order to create revenue streams is known as rent-seeking [W].

References

  1. Tech Dirt describes "artificial scarcity" in an article published on 23 February 2012, retrieved 30 August 2013: http://www.techdirt.com/blog/innovation/articles/20120116/22095317427/real-scarcity-is-important-part-business-model-artificial-scarcity-is-terrible-business-model.shtml - archived here: http://archive.is/xqBMz
  2. The Problems of Scarcity & Abundance
  3. Phi Kappa Phi (1952). Phi Kappa Phi journal. Honor Society of Phi Kappa Phi.