1. Explain what is meant by the term “freeconomics”.
“Freeconomics” is a new philosophy invented by writer Chris Anderson, and his thesis is that more and more goods and services are being provided for free (such as free music/books online, free cellphones, etc.), and businesses which do not follow this trend will most likely fail.
2. How can firms afford to make goods and services available for free?
Firms make their goods and services available for free by cross subsidization, which allows them to make profit from one aspect so that the other can be available for free. For example, with Skype, people can chat and make normal calls for free, but they must pay a considerable amount for premium calls. Social networking sites such as Facebook and Tumblr are also available to everyone for free, but they make profit from advertisements. Smartphones have many free game apps which get customers hooked, making them by things like merchandise, which the firm makes profit from. The article stated that Apple was considering giving customers unlimited free access to their entire iTunes music library if they were willing to pay more for the actual iPod or iPhone.
3. Anderson’s idea is that “the internet, by reducing marginal costs, encourages businesses to make their money by offering free goods or services to an extent we have not witnessed before”. Discuss the extent to which doing business over the internet reduces marginal costs.
The internet reduces a firm’s marginal costs to a large extent; “on the web, the marginal costs of manufacturing and distribution are zero, or close to it”. This is because the internet allows the firm to cut down on the expensive explicit costs (land, labor) that a traditional business must pay. The article gave the example of hard drives. Hard drives are fixed costs, however, they can serve tens of thousands of users, which means even if costs to create it (labor, capitol) in the first place, once it is created, the marginal costs fall because there is barely any need for additional labor or capitol. Also, since hard drives/servers are all made through technology and used online, there is no cost for land. The internet is powerful in reducing marginal costs and making many goods/services available for free.
4. Using your knowledge of economics, draw 2 diagrams from microeconomics that help explain the concepts in this article.
- Marginal Cost Curve
- Abnormal Profits