Deadweight Loss

Katy Perry in Berlin

Alex Tabarrok takes a stab at popularizing the concept of “deadweight loss.” It’s an important one, but I think it’s unfortunate that his chosen example draws specifically from the realm of excise taxes where I think the general spirit of the point (“taxes impose losses”) is pretty well-understood.

What about the case of unauthorized downloading of music files. Consider Katy Perry’s “California Gurls”. This tune costs $1.29 on iTunes. At that price, some people will buy it. Others will refuse. You might refuse because you hate Katy Perry and hate the idea of owning one of her songs. But say you’re not a hater. You’re just a skeptic and a cheapskate. You’d gladly pay a dime for the song were that an option, and since the marginal cost of distribution is basically zero it would be profitable to sell you the song for a dime. But it’s not an option, since the overal profit-maximizing price is $1.29. And say there are a million people like you out there. That adds up to $100,000 in deadweight loss—the value of the transactions blocked by copyright protection.

Of course in the real world many of those million people will just download a copy of the song for free. Some would like you to believe that this is an action that should be analogized to hijacking a ship, threatening to murder its crew, and then stealing the ship’s cargo. But unlike piracy, unauthorized copying can often be highly welfare-enhancing because of deadweight loss. Similarly, even though everyone seems to hate price discrimination, deadweight loss means it can be welfare enhancing as well since more precisely tailored pricing lets firms give some folks a discount.