Digital Piracy: A Competitive Analysis

In recent years, the issue of copyright protection for intellectual properties such as computer software, music CDs, and videos has become increasingly important. It is often claimed that illegal copying of intellectual property costs companies billions of dollars in lost revenues and reduces firms' incentives to innovate. Some researchers have shown that copying can be beneficial to firms when there are strong network effects and copying expands the market. In this paper, we first examine the impact of illegal copying of software and other similar intellectual properties on firms' prices, profits, and quality choices, even when there are no network effects and the market is saturated. We show that contrary to the claims of manufacturers, there are conditions under which copying can increase firms' profits, lead to better quality products, and increase social welfare. This is because weaker copyright protection enables firms to reduce price competition by allowing price-sensitive consumers to copy. Thus, weaker copyright protection can serve as a coordination device to reduce price competition. We also examine how equilibrium copyright enforcement is affected by network externalities. In contrast to previous research, we show that strong network effects can sometimes lead to a firm choosing higher levels of copyright protection. Our results show that in the presence of strong network effects, stronger copyright enforcement by one firm can serve as a coordinating device to reduce price competition.