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