Piracy on the Internet: Accomodate it or Fight it? A Dynamic Approach

Abstract

This paper uses a dynamic stochastic model to solve for the optimal pricing policy of the music recording companies in the presence of P2P file-sharing networks eroding their CD sales. We employ a policy iteration algorithm on a discretized state space to numerically compute the optimal price policy. The realistically calibrated model reflects the real-world figures we observe and provides estimates of figures we can not observe, such as changes in total welfare. The results suggest that, thanks to the existence of P2P networks, total welfare in 2008 in the U.S. is about $25.6 billion more per annum than in 1999 before P2P was introduced. Moreover, the results predict that the current trend of decreasing CD sales will continue until around the year 2020 when it will stabilize at around 231.2 million copies per year, comparing to the industry all-time high of 938.9 million in 1999. The comparative static analysis shows that full enforcement of intellectual property rights, although helpful for the industrial profit, may have adverse effect on total welfare.

Keywords: dynamic price competition, music industry, piracy, P2P networks

JEL Classification: L11, L82, L86