Copyright. Intellectual property analog to patent protection as it applies to the creation of...

Copyright

CopyrightCopyrightIntellectual property analog to patent protection as it

applies to the creation of expressive worksCopyright applies to books, movies, songs, operas, paintings,

computer codeCopyright protects the expression of ideas, but not the ideas

themselvesWhile copyright is less important than patent protection in

directly stimulating innovation, there are major industries in the U.S. which are built around copyright

Publishing: $23 billionMusic: $40-50 billionEntertainment: $60 billion

Basic Copyright DoctrinesBasic Copyright Doctrines

Copyright laws and treaties prohibit unauthorized copying of original expressive works, either verbatim, or in a form that leaves the resulting copy “substantially similar” to the original

The originality restriction in copyright law does allow for independent creation of two substantially similar works

This is different from what we saw in patent lawDifference exists because patents issue only after a search of

the prior art, whereas copyright does notIndependent creation is thus a defense against copyright

infringement


Copyright protects the expression of ideas, but not the ideas themselves

From the U.S. Code: “In no case does copyright protection for an original work of authorship extend to any idea, procedure, process, system, method of operations, concept, principle, or discovery, regardless of the form in which it is described, explained, illustrated, or embodied in such work.”

Example: I have proven a theorem and written a paper expounding on the result and providing the proof. The published paper is subject to copyright protection, but the ideas in the theorem or proof are not.

Real life example: Sega Enterprises Ltd. Vs. Accolade, Inc


Facts are not copyrightableCompilations of facts which embody sufficient creative input

can be copyrightedAlthough the Supreme Court’s ruling in Feist Publications, Inc. vs.

Rural Telephone Service Co. (1991) imposed limits on what constitutes sufficient creativity

Use of the facts in such compilations are not prohibited, although wholesale copying of the compilations is

Issue of database protection in the digital age


Derivative worksThe Copyright Act defines a derivative work as “a

work based upon one or more preexisting works, such as a translation, musical arrangement, dramatization, fictionalization, motion picture version, sound recording, art reproduction, abridgment, condensation, or any other form in which a work may be recast, transformed or adapted

Basic Copyright DoctrinesBasic Copyright DoctrinesDerivative works cannot be copyrighted, unless the underlying

work on which the derivative is based is already in the public domain

Copyrightability of the derivative requires the same “significant creative input” that copyright for original work does

Copyright obtained for a derivative of a work in the public domain does not restrict access to the original work in any way

> A new edition of Adam Smith’s Wealth of Nations can be copyrighted, but Smith’s words can still be used freely by anyone wishing to do so

Derivative works based on a work still under copyright protection cannot used commercially without permission or license from the copyright holder of the original work

Derivative modifications for personal use are not considered infringement, however


Note that this doctrine differs significantly from the parallel doctrine in patent law

Patents can be obtained for significant improvements on an existing, patented innovation

The review process for patents makes it feasible to actually determine the extent and scope of an improvement


Copyright law treats the similar case of derivative works differently for two primary reasons

Transactions costs> Unlike useful technical innovations which occur relatively infrequently,

there may be many derivatives of a major expressive work> Book Movie Action figures, lunch boxes, posters, DVDs> If creators of derivative works could copyright individually, downstream

innovators would be forced to search exhaustively for prior copyrights to ensure they are not infringing with their own derivative work, or to negotiate multiple licenses from existing copyright holders before engaging in the new derivative

Term extension issue> If derivative works can be copyrighted, copyright holders can use this to

effectively extend the terms of their original copyrights


Fair UseFirst codified in the 1976 Copyright ActThe act states that “the fair use of a copyrighted work

for purposes such as criticism, comment, news reporting, teaching, scholarship or research, is not an infringement of copyright”

Basic Copyright DoctrinesBasic Copyright DoctrinesEconomic basis for the fair use doctrine rests on three distinct

cases of the interaction of transactions costs and harm done by the waiver of copyright

CASE I: High transactions costs, no harm> Use of short segments of copyrighted material in activities which do not

detract from the commercial viability of the original work is considered fair use

> Transactions costs arise from the need, in the absence of a fair use exception, to negotiate use licenses for every instance of such activities

CASE II: Negative harm, implied consent case> A book reviewer’s use of short quotations and plot summaries in a

review provides an ex ante benefit to the book publisher and author> Since the credibility of the review depends on the reviewer being

independent of the publisher, consent to copy is implicit in this fair use exemption


CASE III: Positive harm, productive use case> Copyright violations for substantial productive uses are not

considered infringement> A productive use is one in which the copyrighted material is

significantly transformed into a new product with substantial benefits

> Example: Publishing International Ltd. corporation’s Guide to Beanie Babies


Fair use and technologyEvolution of copyright law has always been driven by

technology> Prior to the invention of the printing press, there was no

copyright lawModern digital copying distribution technology is forcing a

major reconsideration of the scope and extent of copyright, as well as with what constitutes fair use

> The Betamax Case: Sony vs. Universal Studios> MGM vs. Grokster

Copyright versus PatentsCopyright versus Patents

Differences between copyright and patent protectionPatents protect ideas that are embodied in useful, novel, and

non-obvious inventionsCopyright protects only the expression of ideas, not the ideas

themselvesPatents are more difficult to obtain than copyright

Patents must undergo review and be approved by the U.S. PTOCopyright can be obtained by simply putting © after the title of an

expressive workCopyrights may be registered with the U.S. Copyright Office in the

Library of Congress, but registration is not necessary for legally binding copyright protection

Why Copyright?Why Copyright?

Standard argument: fixed costsCosts of expression include the time and effort of the

author plus any fixed costs associated with publishing the work

If others can copy and distribute freely, competition drives the price of the work down to marginal cost, making it impossible to recoup the up-front cost of creation


Factors that limit copying without copyright protectionPossibility of recouping investment on first sale (Boldrin & Levine)

Simple model: market for MP3s> Suppose there is a technology which makes it possible to produce

copies of an MP3 file at zero marginal cost> The market for a particular MP3 consists of a continuum of consumers

indexed by c each of whom values listening to the MP3 as c-. Thus, we are simply ordering consumers according to their valuations, with consumers with larger values of c putting lower value on the MP3.

> Suppose that a constant fraction of consumers 1-who purchase a copy of the MP3 use copying technology to make copies of the file which they then share for free, while the remaining fraction purchase the song

> Consumers decide in each period of time whether to purchase or not, and discount the future by <1


Equilibrium in the model> At any time t, the stock of MP3 files will be

This follows from the fact that in the initial period, there is one copy of the song, x0=1. In period 1, there will be

copies. In the next period, there will be

ttx 11

111x

2

1

112

11

11

1

x

xxx


> Iterating this argument yields the desired form for xt

> Since the market is competitive at any time t, the intersection of market supply xt with the market demand curve given by c- will determine the period t price of the file paid by those consumers who are buying the song as

> The discounted value of the song is then given by

tt xp

111

111

0

t

t

t

Why Copyright?Why Copyright?> Calibration:

» = 0.97» = 100» = 0.5

> Cases» Suppose first that , so that everyone buys their copy» In this case, the present value of the MP3 is

» Now, suppose . In this case, the present value of the MP3 will be

33.3303.0

1

1

1

16.1

50197.01

121

Why Copyright?Why Copyright?> Finally, if so that only the first copy of the file is sold,

the present value of the MP3 is 0.90Discussion

> Obviously, the more people who copy the file and the easier it is to copy, the lower the value of the MP3.

> On the other hand, if the cost of writing and recording the song in the first place is not large, it may be possible to recover this cost without the protection of copyright

> Current experience with iTunes suggests that a reasonable fraction of people will purchase their music

> Modern computer technology is simultaneously making it easier to copy and share files, and at the same time, easier to record and distribute music


If copying technology ends up producing inferior copies (VHS, for example), copyright may not be necessary

There may be contractual alternatives to copyright, such as licensing, though licensing can be difficult to enforce unless the number of licensees is small

Technological fixes to prevent copyingCurrent effort to implement digital rights management systemsUse of encryption to “lock” out copyingWe will return later to the issue of social costs associated with this

alternative


Site licensing can eliminate the need for copyright enforcement by compensating the copyright holder up front for the right of a particular group to make unlimited copies

Academic libraries typically view the large fees they pay publishers as a de facto site license for members of their community to make copies of journal articles, whether from print or digital formats

Open source incentives can often outweigh pecuniary incentives for expression, and hence moot the need for copyright protection

Parallels the distinction between basic and applied R&D


Technological change resulting in greater efficiency in the creation and distribution of expressive works can also of itself reduce the need for copyright protection

Example of the artist-oriented business model of music, where the costs of creation may be recouped independently of any enforcement of copyright

Negative example of the motion picture industry, where reduction of copying costs will derail production in the absence of copy/copyright protection and enforcement

> But think also about “Sky Captain and the World of Tomorrow”

Copyright Benefits and Costs


BenefitsFor expressive activities in which the set-up costs cannot be

recouped on the first sale (or on limited sales to individuals willing to pay for copies) some form of protection against unauthorized copying is necessary for the activity to be feasible

Copy protection or copyright?Copy protection uses technology to prevent unauthorized copyingEarly instances of copy protection for software were often clunky and

not user friendly, leading to alienation of customersMore modern technologies rely on encryption to lock out copying by

making copies useless



Even modern encryption-based approaches impose social costs> Resources devoted to hacking of encryption-based protections: arms

races> De facto restrictions on so-called fair use copying for backup, for sharing

with family members, etc.Other forms of copy protection – private circulation of works, non-

publication of dramatic material – impose social costs by making such works unavailable

So, just as patent protection economizes on resources associated with maintaining trade secrets and makes new technologies readily available, copyright may minimize the social costs associated with copy protection activities and counter-activities, and encourages the production of new and original expression



CostsAs with patents, copyright can lead to wasteful rent-

seeking behaviorSuperstar phenomenonMay draw excessive resources into publishing (broadly

defined) in the hope of striking it richNote counter-argument, however: striking it rich may be

the required compensation ex post for drawing sufficient resources into publishing to ensure ex ante that high value works get created



Copyright – particularly when granted for very long periods of time – keeps valuable expressive content out of the public domain

Works in the public domain can be re-used to build new expressive content which itself has value

Example: Shakespeare’s use of stories and characters from previous authors’ works

Northorp Frye’s dictum (from The Anatomy of Criticism, 1957): “poetry can only be made out of other poems; novels out of other novels”

Incentives thus exist for authors and creators to favor limited copyright in order to preserve the intellectual public domain

An Economic Model of Copyright


We will use the model to examine the cost-benefit trade-off associated with copyright

Assumptions:Creators and copiers produce quality-adjusted copies which

are perfect substitutesDemand is not subject to uncertaintyCreator’s face fixed costs of creation and constant (possibly

zero) marginal cost of copyingCopiers face variable marginal costs of copying but no fixed

costs



NotationWe will denote the price of a copy by p and the demand for copies of a

work at this price by q(p) Let x and y denote the number of copies the creator and copiers produce

respectively, so that q=x+yWe denote the creators marginal cost of copying by c and the fixed cost of

expression by e, and assume that the cost of expression increases with the degree of copyright protection

The degree of copyright protection is denoted by z where z=0 denotes no protection while z=1 denotes complete protection: no copying whatsoever is permitted except under license

The degree of protection will depend on how alike two works must be to infringe, the elements of a work that are protected, the duration of protection, and the costs and effectiveness of enforcement



CopiersCopiers are assumed to be competitive, like the fringe firms in a market

with a dominant firmCopiers will supply copies up to the point where the marginal cost of

copying equals the priceCopiers marginal costs are assumed to be increasing in the level of

copyright protection and in the number of copies producedThis assumption is justified because there are different types of copiers

> Fair use copying is low cost and low riskCommercial piracy is risky and hence increases the marginal cost of copying,

and different pirates may have different levels of risk aversionIn addition, piracy copying may not have uniform access to the best copying

technology



Copiers’ supply curve is then given by y(p,z) with yp>0 and

yz<0

q

P, MC Y(p,z)Y(p,z’)

p

z’>z

qq’



Author’s profit is then given by

Denote the author’s revenue by R=(p-c)xAn author will create a work only if R ≥ e(z) Now, let N denote the total number of works produced

We will assume that different authors have different costs of expression, so that with free entry into the publishing market, the equilibrium number of works will be such that the cost of expression for the marginal author just equals his revenue.

zezpypqcp

zexcp

,



The supply of new works will thus be N=N(R,z) Given our assumptions on the effect of copyright

protection on the cost of expression, it also follows that NR>0 and Nz<0

We would like to know how an increase in copyright protection affects the production of new works.



The effect of a small increase in copyright protection is given by

The sign of this expression depends on the interplay between the two terms

The first term is positive, since a movement up the supply curve will lead to an increase in revenue as the increased degree of copyright protection reduces piracy

The second term, however, is negative since an increase in z increases the cost of expression for marginal authors, leading to an upward shift in the supply curve

zR Ndz

dRN

dz

dN



Cases:When z is small, the revenue effect is likely to dominate, since

increased copyright protection makes it easier for authors (or publishers) to prevent free riding by copiers, and hence, their revenue goes up

At the same time, when z is small, the cost of expression is small and an increase in z is not likely to increase these costs by much

Hence, for this case, we will have 0dz

dN



Cases:When z is large, the effect of increasing the cost of expression

for marginal authors should begin to dominate, since there will already be a large number of works being created, so that revenue increases by less than the cost of expression

Hence, for this case, we will have

0dz

dN



It now follows that that there will be a critical value for which

Obviously, the number of new works is maximized at this level of copyright protection

z

0zdz

dN



Market analysisKeep in mind from our previous discussion of copyright

doctrine that there are different ways for authors or publishers to deal with a new work, including licensing derivative works, and hence, there are different dimensions to copyright protection

Hence, we should interpret our number z in the model as being an index of overall levels of protection, including modifications such as the exclusion of protection for ideas, and the permitting of fair use infringements



With these caveats, we will do a supply and demand analysis for the market for “copies” given a fixed level of copyright protection, which we denote by z0, and then examine how an increase in the degree of copyright protection affects the equilibrium in this market



p

q

y(p,z0)

q(p)

Creator’s derived demand for copies

Creator’s marginal revenue schedule

MC=c

p0

y0 x0 q0

R0



p

q

y(p,z1)

q(p)

MC=c

p1

y1 x1 q1

R1

Effect of an increase in copyright protection



We look next at how the increase in copyright protection affects the overall number of works (which provides a measure of social welfare) under the assumption that the increase in copyright protection increases creator revenues



N=N(R,z0)$

N

R=R(z0)

R=R(z1)

N=N(R,z1)

N0 N1

R1

R0

N=N(R,z1)



Social welfare effectsFrom our analysis of the market for copies and new works, we

see that an increase in copyright protection has two different effects:

The increase in price and reduction in the number of copies produced imposes a deadweight loss in consumer surplus in the market for copies

The increase in creator revenues increases producer surplus, but the upward shift in the supply schedule for new works reduces producer surplus

The optimal level of copyright protection thus balances the overall positive and negative effects on the production of new works and copies of these works



Creator’s profit maximization and the price of a copy

The typical author/publisher in the market will choose the price of a copy to maximize profit, i.e. to solve the problem

zezpypqcp , maxp



The first-order conditions for this problem are

These first-order conditions can be rewritten as

Here α is the fraction of all copies made by the author, qp is the price elasticity of demand, and yp is the price elasticity of supply from copiers

0, pp yqcpzpypq

ypqpp

cp

1



Effect of an increase in copy protection on profitEffect on revenue is given by

z

zpp

zpp

ycp

ycpdz

dpyqcpx

ydz

dpy

dz

dpqcpx

dz

dp

xcpdz

d

dz

dR



Since the effect on costs is just ez the net effect will be given by

To determine when this will be positive or negative, we use the fact that for the marginal author, revenue just equals cost, no matter what the level of z.

zz eycpdz

d



Since

x

yy

y

x

x

y

x

z

dz

dy

x

z

dz

dxx

dz

dy

dz

dx

dz

de

dz

dxcp

dz

d

zz~~

writecan we

while

)(



It follows that

zz

zz

zz

z

eyx

y

z

e

ez

ey

x

y

z

xcp

ez

ex

z

xcp

z

e

e

z

dz

de

z

x

x

z

dz

dxcp

~~

~~)(

~~)(

)(



We use the fact that at equilibrium, the marginal author always has revenue = cost to get to the last step.

It now follows that

zzz e

x

yy ~~sign

~sign



Optimal copyright protectionWe adopt the usual notion of social welfare as the sum of

consumer and producer surplus generated in the marketNote that producer surplus will be the sum of profits earned by authors

plus the profits earned by copiersTotal welfare must also consider the effect of copyright

protection on the overall number of works created, as well as on the surpluses generated by each work

This point is stressed by Landes and Posner in their book The Economic Structure of Intellectual Property Law, as being in contrast to conventional analysis which focuses only on the welfare effects generated by a given work



Social welfare function: W[N,w,E(N,z)]Here N is the number of works created, which as

argued earlier depends on revenue from sales of works, and on the level of copyright protection

w is the average social welfare of a given work, which is given by

dpzpyzpypqcpdppqwp

pp

*

* 0

,*,*)*(



Social welfare function: W[N,w,E(N,z)]The function E(N,z) is the cost of expression, which depends

on the number of works, and on the level of copyright protection

Dependence of E on N is due to transactions costs for use of material in other copyrighted works, when z>0, and because of greater costs of administering the copyright system when there are more works being created, and hence more litigation over infringement

We assume that E is increasing in N and convexDependence of E on z is due to the enclosure effect in reducing the

public domain; we maintain our usual assumptions that E is increasing and convex in z



For convenience, we will assume that the social welfare function takes the form

where f(N) weights the average social welfare of a given work to reflect the total number of new works available

We also assume that f(N) is increasing and concave

zNEwNfW ,



Maximization of the social welfare function yields first-order conditions

To analyze this expression, we need to calculate

0 zzNzzN ENEfwwNf

dpzpyzpypqcpdppqzz

wp

pp

*

* 0

,*,*)*(



dpyycpzpx

dpyycpzpypq

dpydz

dpzpy

dz

dpzpyy

dz

dpyqcp

dz

dpzpypq

dz

dppq

z

w

p

p

zz

p

p

zz

p

p

zo

zpp

*

*

*0

0

0

0

)*()*,(

)*()*,(*)(

),(

*)*,(

*)()*(

*)]*,(*)([

**)(

dpzpyzpypqcpdppqzz

wp

pp

*

* 0

,*,*)*(



So, by direct calculation, we get

InterpretationBecause increases in z reduce the amount of fringe copying and increases the

price, the author’s revenue goes up by the mark-up over marginal cost times the reduction in fringe copying, but falls by the amount of previous non-fringe sales since these consumers are now being priced out of the market

Which effect dominates is ambiguousThe social welfare due to fringe copying fallsIncreased cost of expression also reduces social welfareNet effect is a likely reduction in overall social welfare, except at very low

levels of z

*

0

)*()*,(p

p

zzz edpyycpzpxz

zew



Analysis of optimal degree of copyright protectionRewrite the FOCs for the social welfare maximization

as

Assuming that wz<0 it follows that the right-hand side of the FOC is positive

On the left-hand side, Nz may be either positive or negative, but at the optimal copyright level z* it will be positive

zzNNz EfwEwfN



Interpretation:At the optimal level z* since the right-hand side of the FOC is

positive, we must have fNw-EN>0This implies that the marginal utility of the social surplus of new works

must exceed the cost of creating the marginal workEffect of new technology on optimal copyright

> Consider extreme case where technology makes it impossible to prevent unauthorized copying and distribution. In this case, we would expect wz to go to zero since changes in copyright can’t be enforced

> Given this, the RHS of the FOC is smaller, so we need Nz [fNw-EN] to become smaller, which can be accomplished by reducing z, since Nz>0

zzNNz EfwEwfN



Interpretation:At the optimal level z* since the right-hand side of the FOC is positive, we

must have fNw-EN>0

Effect of new technology on optimal copyright> Posner and Landis note that if the effect of the technological change increases

overall social welfare or reduces the marginal cost of expression with respect to the number of new works, it may be optimal to increase the degree of copyright protection, since this will make the RHS of the FOC larger.

> But this result is ambiguous in the model, since it is possible that the technological change may leave the marginal impacts of changing copyright protection on social welfare and cost of expression unchanged, in which case, we can reduce the LHS of the FOC by reducing copyright protection and making N smaller.

zzNNz EfwEwfN



Interpretation:At the optimal z* we are not maximizing the total

number of works: Nz≠0This reflects the trade-off between the benefit of

providing more works by providing greater copyright protection and hence higher incentives to create new works, and the costs associated with reducing the extent of the public domain, reducing the welfare generated by each new work, and the increased costs of enforcement

zzNNz EfwEwfN



Interpretation:If Ez is large, the degree of copyright protection should be

smallA reduction in z will typically make w and N largerSince f is concave, this makes fN larger, together with the increase in

w, thus making the left-hand side largerThis result is the basis for the various fair-use doctrines

included in copyright lawTransactions costs if wide-scale licensing is requiredLoss of productive value in positive harm, productive use cases

zzNNz EfwEwfN

Copyright and ContractsCopyright and Contracts

A missing realistic feature of copyright is the fact that content creators generally sign away their rights to publishers as part of the contract the author signs to have her work published.

We examine this aspect of the economic relationship between author and publisher, and the impact of copyright protection on the provision of works done under contract, using the tools of agency theory

Agency ModelsAgency Models

Economists use so-called agency models to study contractual relationships between two parties to an economic relationship in which the parties may have different objectives

Example: insuranceParties to the contract are the insurance company and the

individuals buying insuranceWe will assume we have a monopoly insurance company who

provides insurance to a continuum of individuals who face the same risk of loss

Car insuranceRole of the law of large numbers


Notation= insurance premiumx = payment if an accident occurs= probability of accidentyH = wealth if no accident occursyL = wealth if accident occursInsured agents are risk-averse, with utility of wealth

given by u(y)=ln(y)


Insurance company’s problem is to choose the policy parameters and x to solve the optimization problem

subject to

Constraint is called the participation constraint

xx

1 max,

uxyy LH ln1ln


First-order conditions are

Rearranging, we haveSo

Agents are fully insuredActual levels of the premium and payout are determined by substituting into

the participation constraint and solving for lambda

0

11

0

xy

y

L

H

xyy LH


This insurance model is a very simple example of the agency relationship, but isn’t very realistic

More realistic version would allow for private information, reflecting the fact that

for car insurance, drivers can take actions, such as not speeding, wearing seatbelts, keeping their cars maintained, which mitigate the risk of loss, but which may generate disutility

CEO’s can take actions which enhance shareholder wealth but can’t be directly observed by shareholders, but which require costly effort on the CEO’s part

Managers, independent contractors, or franchise owners generally work without supervision, and may engage in shirking behavior

Agency ModelsAgency Models To address the issues associated with asymmetric information, we modify the

basic insurance model by assuming that the agent can exert effort which affects the probability of the good outcome occurring. The simplest way to do this is to assume that the effort a is between 0 and 1 and corresponds directly to the probability of a good outcome

We also introduce a function which specifies the disutility the agent incurs from exerting effort

We denote the disutility of effort by a) and assume that this function is strictly increasing and strictly convex

To complete the specification of the model, we need to restrict the set of possible dividends and payouts the insurance company can choose so that the agent will find it optimal to take the action the insurance company desires

We do this by introducing an incentive compatibility constraint, in which we assume that given the policy parameters, the agent will choose a utility-maximizing action


Formally, the insurance company’s optimization problem now becomes

subject to

xaaax

1 max,,

1,0'any for

'ln'1ln'ln1ln

ln1ln

a

axyayaaxyayaIC

uaxyayaPLHLH

LH


As before, constraint [P] is the participation constraint[IC] is the incentive compatibility constraint and simply

says that the agent will always choose a utility maximizing action given the policy parameters

In working with these models, it is common practice to replace the full incentive constraint with the first-order condition for the agent’s utility maximization, which will always be both necessary and sufficient for a to maximize utility as long as the agent’s expected utility function is concave in a


Making this substitution, the insurance company’s optimization becomes

subject to

xaaax

1 max,,

0'lnln

ln1ln

axyyIC

uaxyayaPLH

LH


Letting be the Lagrange multiplier associated with the participation constraint, and be the multiplier associated with incentive compatibility, we obtain the following first-order conditions for the optimization

0

01

0

aa

LL

HH

x

xyxy

aa

yy

aa


From the first two conditions, we can solve for and x as

These expressions can then be used in the third FOC and the two constraints to find the optimal values of a,x, and

L

H

ya

x

ay

1

Agency ModelsAgency Models To compare the results from this model with the simpler model, note that from

the FOCs, we have

In the full insurance model, the good and bad state incomes were the same, but in the presence of asymmetric information, the optimal insurance policy gives the agent higher good state income than bad state income

Intuitively, this corresponds to imposing a deductible on the agent, which forces her to bear some of the risk associated with bad behavior

This residual risk helps to motivate the agent to avoid the bad behaviors

axy

ay

L

H

1

Agency and CopyrightAgency and Copyright To use the agency framework to examine copyright issues, we need to modify the standard model

to make it one of a contract between a publisher and content creator. In the basic form of this model, the publisher is the so-called principal (the insurance company in the previous analysis) and the content creator is the agent

We assume that the content creator can produce content of either high quality or low quality, with greater effort leading to a higher probability of high quality

The realized quality of the content is observable to both principal and agent, but the agent’s effort is private information

The principal is assumed to be risk neutral The principal offers the agent a contract which specifies a contingent wage depending on the realized

quality We assume, as before that the effort level a is just the probability of high quality We denote the high quality output by yH and the low quality output by yL

Similarly, we denote the wage paid when high quality results by wH and the low quality wage by wL

We note that real world book contracts specify the royalty payouts as a percentage of sales earnings, but actual payouts are contingent on sales milestones being achieved

Agency and CopyrightAgency and Copyright

For this contacting problem, then, the principal’s optimization problem takes the form

subject to

LLHH

awwwyawya

LH 1 max

,,

0lnln IC

ln1ln P

aww

uawawa

aLH

LH



0

01

1

0

aaLLHH

LL

HH

wywy

ww

aa

ww

aa

Agency and CopyrightAgency and Copyright As in the insurance problem, the first two conditions can be rewritten as

so that the optimal contract provides incentives that encourage the production of high quality. It also follows easily that is just the expected wage for the agent. Finally, the remaining FOC and the constraints can be used together to find the values of a and the two Lagrange multipliers.

aw

aw

L

H

1

Agency and CopyrightAgency and CopyrightTo use this analytic framework to study copyright, we need three additional modifications of the model

We will reinterpret (a) not as disutility of effort, but rather as an outside activity – conferences, concerts, interactions with other artists, writers, movie producers, etc. -- that gives the content creator direct utility, but at the cost of reduced effort toward production of quality for the principal

We also introduce a parameter, z, as in the competitive fringe model, which measures the degree of copyright protection, with larger values of z denoting more stringent protection

Since the activities of the content creator benefit from a more extensive public domain, and are hurt by restrictions on the public domain, we will add the assumption that the function depends not only on a, but also on z, and assume that the derivative z<0 for any value of a.

Since we can view the content creator’s outside activity as one directed toward the accumulation of creative capital that ultimately benefits the overall process of creating new knowledge or works, we assume that the average level of positively impacts the output of high quality works

Finally, we also assume that there is a function g(z) which is increasing in z and which multiplies yH to capture the idea that increased copyright protection, by reducing piracy, leads to higher value for high quality sales for the principal

The key assumption here is that the positive benefit of the public domain, working through is external to the principal’s optimization problem, just as it is the human capital effect in the endogenous growth model


For this version of the model, the principal’s optimization problem is

subject to LLHH

awwyawyzga 1 max

,

0,lnln

,lnln1

zaww

uzawawa

aLH

HL



0

0

01

1

aaHHLL

HH

LL

wyzgwy

ww

aa

ww

aa


As before, the first two FOCs can be rewritten as

which captures the incentive effects in the contract. As in the previous models, we can use these conditions with the third FOC to solve for actual values of and

aw

aw

H

L

1


Optimal copyrightWe now assume that we have solved for the optimal actions and wages in

the model. These will generally be functions of the degree of copyright enforcement z, so we can ask what the model predicts as the optimal level of copyright protection.

The principal’s payoff for a given level of copyright protection is given by

Here, the ^ notation denotes the optimal value of a variable given the level of z

LLHH wyawyzgaV ˆˆ1ˆˆˆ


Optimal copyrightTaking a first derivative with respect to z gives us

Fortunately, this simplifies considerably, since the partial derivatives taken with respect to a, wH and wL all vanish because they are just the first-order conditions for the principal’s optimization problem.

)('ˆˆˆˆˆˆˆˆ

zgaydz

dV

dz

wd

w

V

dz

wd

w

V

dz

ad

a

V

dz

Vd HL

L

H

H


Optimal copyrightAs a result, we are left with

We now wish to address the question of whether z=0 can ever be optimal. To do this, we need to make assumptions on the function g, which we recall captures the effect of reducing piracy on the principal’s sale of high-quality output.

')('

ˆˆ

ggay

zgaydz

dV

dz

Vd

zH

H


Optimal copyrightWe assume thatg(0)=1g(z) is increasing and concave (i.e. IP enforcement increases

sales but there are diminishing returns to it).With these assumptions, z=0 will be optimal if

0)0(')0,(

)('ˆˆ

gaay

zgaydz

dV

dz

Vd

zH

H


Optimal copyrightSince a and yH are both positive, the condition boils down to

Since is always positive, then the question of optimality becomes simply one of whether the positive marginal impact of introducing copyright protection in an environment where there is initially no protection on sales outweighs the negative impact the introduction of copyright has on the accumulation of creative capital.

0)0(')0,( gaz


Optimal copyrightThe answer to this question is obviously an empirical oneThe rate at which copyright increases sales obviously also

depends on technology of reproductionIn an environment such as the internet where enforcement is quite

difficult and costly, moving from a zero copyright regime to one with positive copyright protection won’t have much impact on existing sales

As Boldrin and Levine point out in their example of Charles Dickens’s U.S. book sales, it is distinctly possible that introducing copyright can actually harm sales


Optimal copyrightOn the creative capital side, imposition of copyright has the

immediate and dramatic impact of making the sale of derivative works illegal

To the extent that enforcement of this prohibition is effective, we would expect to see a substantial reduction in this kind of creative capital accumulation

This in turn suggests that the overall costs of imposing IP protection outweigh the benefits of providing it and that content owners would actually better off without it.

Copyright and Technology Revisited


Betamax caseThe Supreme Court’s ruling that technologies which contribute to the

infringement of copyright in the Sony vs. Universal Studios case was essentially a finding of fair use based on the positive harm, productive use doctrine

Unlike the other fair use doctrines, the economic rationale for the PHPU case is not based on how it affects the costs of expression, but rather on the social welfare loss associated with excessive protection

The Court found that in the Betamax case, the loss in social welfare associated with upholding a charge of contributory infringement outweighed the costs to the entertainment industry of collateral infringing activities by some users



The MGM vs. Grokster caseIn the Grokster case, the Supreme Court essentially upheld the precedent

from the Betamax case, ruling that peer-to-peer network technology had the requisite “substantial non-infringing uses” to make the technology subject to the PHPU doctrine

However, the Court narrowed the scope of the Betamax exemption by finding that Grokster’s promotion of its software was based in large measure on its application for illegal downloading of music, and that this behavior could be prosecuted as contributing to the infringement of music copyrights by Grokster’s users

So, we turn next to public policy and the questions of whether U.S. intellectual property laws are achieving the right balances

Copyright. Intellectual property analog to patent protection as it applies to the creation of...

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