Digital Distribution Meets the Video Game Market

GameStop and EB Games have always been the major players in the used video game market when it comes to retail sales. Given their level of success, it was only a matter of time before other major players, such as Amazon.com and Toys "R" Us, entered the market. But how does this affect the long-term profitability of retailers, game publishers, and game developers?

The short-term motivation of retailers such as GameStop buying and selling used games is that they share none of the profit with developers of the game. Game publishers and developers only receive a payment for the sale of brand new games and are thus negatively affected by the growing used video game market, especially during bad economic times when sales are already lower than desired. Although buying used games instead of new titles might only save consumers $5-$10, some GameStop stores also allow you to return used games within 7 days if they don’t work properly or you simply don’t like the game, an option unavailable if you pay for a new game.

Incentives play a crucial role in economic analysis. Properly aligned incentives can promote desired outcomes in the short run and long run. From the perspective of video game developers, the lost revenue from video games trading hands multiple times in the used market is evident. As an increasing number of retailers realize the gains from entering this market, video game developers will experience decreasing gains from the production of new games.

This provides publishers with the incentive to consider other mediums of distribution, in particular digital distribution. The video game market is not the first entertainment industry to delve into a more technical solution. In the music industry, CDs are being replaced by iPods and MP3s thanks to Apple's iTunes. In the movie rental industry, we have gone from renting at our local store to mailing in movies through services such as Netflix or Blockbuster to downloading movies directly to our TV through the internet or cable services.

Therefore, it is not surprising that the video game market is heading in this direction, especially with the growing popularity of the used video game market. Since its inception, the Nintendo Wii has offered games from older consoles for purchase through the Wii Marketplace. Because the Wii offers free Wi-Fi, Nintendo can bypass the middle man of in-person and online retailers. In addition, Microsoft has begun to experiment with this option by offering smaller-scale, arcade-like games for purchase using Microsoft points that can be purchased in the Xbox Live Marketplace. They also offer free demos of newly released games in hopes of attracting additional sales. The drawback with Microsoft is their Xbox Live internet service is not free, so only users with a paid account can access these services.

Discussion Questions:

1. From the consumer perspective, what would your indifference curves look like for these two goods? Do you believe a used game is equally as good as a new game? How would this affect the demand for used video games?

2. What kind of incentives, if any, could a video game developer provide to GameStop to encourage them to sell new games over used ones?

3. How will the growing popularity of releasing and purchasing video games through an individual console change the market structure of video game retailers? How does this compare to the success of the iPod and MP3s in general?

Precious News

News of Barack Obama's historic election on November 4 dramatically increased demand for newspapers on November 5. Tall, bold headlines announcing the nation's new president transformed copies of the daily paper into collector's items. Though many publishers printed thousands of extra copies in anticipation of higher demand for their post-election issue, at newsstand prices, supply simply couldn't keep up with the surge in demand. On Wednesday morning, many looking to own a piece of history found only empty news boxes and long lines in front of newsstands.

Not surprisingly, copies of major newspapers' November 5, 2008 issue began selling for as much as $200 on eBay and Craigslist.

This is a classic example of how a market responds to an increase in demand. The market equilibrium on a normal day for newspapers is at point A with price P1 and quantity Q1. As the demand curve for newspapers shifts rightward from D1 to D2 (people want more newspapers at any given price level), both equilibrium quantity and equilibrium price of newspapers increase as a result—from P1 to P2, and Q1 to Q2. On November 5, the quantity of newspapers supplied increased in part because publishers anticipated higher demand and in part because they scrambled to reprint when demand was even higher than expected. In the end, more newspapers appeared in the market, and at higher prices. The new market equilibrium for newspapers on November 5 is now at point B.



Though the consequences of the sudden shock in demand for November 5 newspapers are pretty much as expected, the reasons behind this shock are not so clear.

Though newspapers received renewed attention after the election, newspaper circulation has fallen steadily across the country for years. The ease of instant access to up-to-date information and the accessibility of free content have turned many readers to the Internet for news. The spike in demand for newspapers after the election raises interesting questions about the value of the daily newspaper in a digital world.

Discussion Questions

1. With the prominence of the Internet, why do you think people still wanted physical copies of newspapers with news they probably already knew? What factors do you think drove up the value of newspapers after the election? What do paper newspapers have that websites do not?

2. Some newspapers also raised the price of their November 5 issue. The Washington Post, for example, increased the price of their special post-election edition from $0.50 to $1.50. Considering the huge mark-ups for copies of November 5's newspaper on the Internet, why didn't newspapers raise their own prices even more, to, say, $20 per copy?

3. Does scarcity exist on the Internet? If so, how does it compare to scarcity offline? If not, how does that affect the value of virtual goods as compared to physical goods?

Net Neutrality

The Internet presents a challenge for economic thinkers. Because it's new and changing rapidly, economists struggle to draw substantive conclusions based on data. As a result, they are largely left to argue over which of the economic models designed to describe the "old economy" are most appropriate for examining the "new economy."

The economic question stirring the most debate right now has to do with network neutrality, or "net neutrality." (Someone asked a ninja recently about it. Someone also asked Greg Mankiw. The ninja had an answer, and Mankiw didn't.) In a neutral network, internet service providers (ISPs) give equal weight to all websites. Suppose AT&T provides your internet service. AT&T recently merged with SBC, which has a partnership with Yahoo. Under the current neutral network, you can conduct searches with Yahoo or Google, and neither Yahoo nor Google have to pay AT&T for delivering their content to you.

Suppose, though, that AT&T could charge websites for the speed of content delivery. If Google doesn't agree to pay for faster delivery of its search results, videos, and other content, AT&T might make the Yahoo site--a business partner--load up a lot faster than Google. Does it have the right to do so? A bill working its way through Congress would give it that right; this has led to a revolt among Internet users and Internet companies like Google.

The opposing sides of the debate use different economic models to support their respective positions. According to supporters of the legislation, sites offering content that uses lots of bandwidth, like youtube.com, currently use ISP-maintained infrastructure for free, and such sites should have to pay for that bandwidth. Because bandwidth is scarce (or becoming scarce as the Internet becomes more congested), the argument goes, allowing ISPs to charge for it will ensure that bandwidth goes to those who can use it most profitably. For example, Robert Litan of the Brookings Institution, argues that using the Internet to deliver health care to disabled people would amount to nearly $1 trillion of cost savings--but only if doctors can be sure that the data they get is uncorrupted by, say, a video broadcast of "Ask a Ninja." Without a market for broadband, those kinds of cost savings will not be realizable. Similarly, Robert Hahn and Scott Wallsten argue that "mandating net neutrality, like most other forms of price regulation, is poor policy." All of these economists treat broadband access as a private good, subject to the usual laws of supply and demand.

Opponents of the legislation are organized on http://www.savetheinternet.com/. They claim the more appropriate model is that of monopoly or oligopoly: ISPs are so large that they would have market power and charge excessively high prices for broadband in order to maximize their profits. Consequently, the number of websites would dwindle, and the Internet would be a much less varied place. More insidiously, this would have a cascading effect on other Internet innovations: the fact that access to Internet users has been relatively cheap up until this point has allowed a myriad of new Internet startups to take risks by creating or entering new markets.

1. Which economic models that you have studied are most applicable to the market for broadband? Why?

2. Hahn and Wallsten argue that as long as the market for ISPs is competitive, the market for broadband will be as well. They suggest that the better way of fostering competition is to ensure that the market for ISPs is indeed competitive. Is this reasonable?

3. Both sides of the debate argue that their position is better for innovation. What kind of innovations might not occur if net neutrality is maintained? What kinds of innovations might not occur if a market for broadband were to exist? Is there any way of weighing the pros and cons of those kinds of innovations?