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Software Economics Economics 101

Software Economics Economics 101 What is the economics of the software industry that gives its products free over the Internet? The Wealth of Nations, by Adam Smith During the 18th century, roads and canals altered how people did business

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Software Economics Economics 101

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  1. Software Economics Economics 101

  2. What is the economics of the software industry that gives its products free over the Internet?

  3. The Wealth of Nations, by Adam Smith • During the 18th century, roads and canals altered how people did business • Today, the electronic network, a.k.a. the Internet, is doing the same • Both types of networks have resulted in a rise in trade volume

  4. How is the Internet made possible? • Through advanced technology: via MODEMS • Ability of modems has increased: • less data distortion and more data compression • internal modems • line probing • multidimensional trellis coding • protocol spoofing

  5. Due to advanced modems, the number of Internet users has increased.

  6. Economic Theory behind the Industry Software • Law of INCREASING Returns, not Diminishing Returns • High fixed cost and low variable cost

  7. Law Of Diminishing Returns

  8. Law Of Increasing Returns

  9. High Profits due to Increasing Returns • High fixed cost: Research and Development • Low variable cost: production and distribution of software • Cost for distribution of software via Internet is close to zero

  10. Also, high profits due to dominating the market. But, how? ESTABLISH A CUSTOMER BASE

  11. Target Computer Owners • Computers are becoming more and more a normal good • Software packages are complementary goods to computers • Some software programs still remain a luxury good

  12. What This Means • Potential customers: people with a higher income • Attract buyers by giving a free sample via the Internet

  13. Next Steps: Keeping the customers • Software must be good and reliable product • Sell upgrades or new versions of the software • Network externalities: other companies build around your software

  14. What about other competitors? • High opportunity cost for customers to switch • The firm with the better technology dominates the market

  15. Where is software economics headed?

  16. Demand-side economics • The pre-Internet market was dominated by a monopoly or oligopoly (Microsoft, Macintosh, etc.) • Post-Internet market is very unpredictable • Role of government? • Darwinism: Survival of the fittest

  17. What is the economics behind the software industry? • Law of Increasing Returns • Formation of monopolies • Establishment of a strong customer base • Little regulation by the government

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