The iTunes Store has always been characterized by the logic of unbundling. Why buy an album? Just buy the few songs on it you like. Why subscribe to cable? Just download the few shows you follow. But as it turns out, the logic of unbundling is not as compelling as it seems. In fact, when goods have zero marginal cost (as is approximately true for movies and music), bundling is very often superior to unbundling.

Here is a quick example. Let’s suppose there are 1000 consumers and 10 songs. Further suppose that each consumer’s value for each song is distributed uniformly and independently between 0 and $1. What does the demand curve for each song look like?

The optimal pricing scheme for the monopolist rights-holder (assuming no price-discrimination) is to charge 50 cents for each song. It will sell 500 copies of each song. It will earn $250 per song ($0.50 × 500), and since there are 10 songs, it will earn a total of $2,500.

And here is the shocking twist. What does the demand curve for a 10-song bundle look like? Given my assumptions above, it is not a straight line. Rather, it will look something like this.

The optimal pricing scheme for the bundle is not to charge 50 cents per song. It is to charge something more like 40 cents per song. At a price of $4, over 800 copies of the bundle will be sold. This is total revenue of $3,200, which is $700 or 28 percent more than the unbundled revenue.

Bundling not only generates higher profits for the rights-holder, it generates more media consumption. Since there are 10 songs in the bundle, a total of over 8,000 songs are sold; unbundled, only 5,000 songs are sold. As the number of songs in the bundle increases, the demand curve for the bundle gets flatter, a greater proportion of consumers wants to buy the bundle, the rights-holder makes more money.

Suddenly, the iTunes Store’s business model doesn’t look so good. Compare the idea of renting movies on your new Apple TV to having access to Netflix‘s entire streaming library of movies. Netflix is a giant bundle that Apple can compete with, for now, only by having better titles. As Netflix’s licensing division negotiates better content deals (which, due to a more effective pricing scheme, it will inevitably be able to do), Apple’s movie rental business is going to wane.

The music side of the iTunes Store is equally in trouble. Companies like Spotify are offering vast libraries of music for rental for very reasonable prices. iTunes is still the world’s largest legal music retailer, but this might be only because Spotify is not yet publicly available in the US. In fairness, the comparison between iTunes Music and Spotify is inexact because iTunes is selling while Spotify is renting, but the basic logic of bundling remains. As companies are able to negotiate the necessary licenses, the unbundled model will fade away.

However, the logic of bundling also means that Apple has plenty of room to improve its offerings. If Apple could beat Netflix and Spotify to the punch and negotiate the requisite licensing first, they could just as easily offer users an enormous bundle. But another revenue generator that Apple hasn’t touched yet is app bundles. Apple should make it easy for App Store developers to band together to offer their apps in a bundle. You’ve heard of MacHeist? It’s the logic of bundling that makes MacHeist a good deal for both developers and consumers. There is no reason that hundreds or even thousands of app developers would not want to participate in bundles on the App store. Greater app sales would mean that Apple would rake in a huge commission.

A lot of people praise the Internet’s ability to allow us to unbundle. We can use RSS feeds to unbundle a column from a newspaper. We can subscribe to a podcast instead of a TV channel. But this is confusing the unbundling of consumption with the unbundling of purchasing. Newspaper columns and podcasts are usually distributed for free; if they are not, then they are almost always part of a bundle that is designed to be more appealing to most people than the standalone product. Unbundling advocates such as the agitators for à la carte cable don’t see this. They think that if a 100-channel cable package costs $50/month, then a 1-channel subscription will cost $0.50/month. But it is only because the 100-channel package contains channels you are not interested in that the cable company can offer you such a low per-channel price.

But whether you think it is a good thing or not, bundling is going to be a pervasive feature of commerce in the digital age. Both you, dear reader, and Apple should get used to it.

[Obama] chided Senate Republicans for engaging in “pure partisan politics” by holding up a jobs bill that would offer tax breaks to small businesses and ease credit with a $30 billion initiative to channel loans through community banks.

Community banks!? That‘s the stimulus plan?

The president also said he and his team were “hard at work in identifying additional measures,” including extending tax cuts for the middle class that are scheduled to expire this year, increasing government investment in clean energy and rebuilding more infrastructure.

What a joke. Sorry, but none of these is going to make a significant contribution to ending the recession.

Maybe we can help Obama identify some additional measures to stimulate the economy. Here are the rules. First, your proposal must be revenue-neutral, or at least very cheap. Second, Sumnerian monetary policy (which I support) is off the table as “too obvious,” as is encouraging people to counterfeit. Third, your proposal needs to provide actual short-term stimulus, not just be good long-term policy.

My proposals:

First, permanently eliminate the employer portion of the payroll tax and charge it to employees instead. Remember, in the long run this change makes no difference whatsoever, since the incidence of a tax is the same no matter who technically pays it, as long as prices are flexible. But the reason labor markets don’t clear in recessions is that the price of labor (the wage) is not flexible. Real wages need to fall to clear the market. Shifting the payroll tax burden to employees would be an immediate cut in real wages, which would induce greater hiring and a lower quantity of labor supplied, moving the market closer to clearing.

Second, let in several million more immigrants. There are 19 million unoccupied houses in the country. The malinvestment in housing has decreased homeowners’ and investors’ net worth, which is creating fear and uncertainty. The wrong way to solve the housing problem is through subsidies which encourage further malinvestment. The right way is to make the malinvestment an ex post good investment. This can be done by importing residents, demanders of housing. Start by eliminating quotas for H1B and student visas, but ultimately, if people promise not to go into the construction industry, let them in. This proposal would have been even more stimulative during the financial crisis when it could have also propped up the value of mortgage-backed securities, but it would still do some good now.

Are there flaws in my proposals? What would you suggest instead or in addition?

From the content of Pete’s post, it’s clear that he’s not asking if the blogosphere is a common-pool resource; rather, he’s asking about the comments that appear on blog posts. Furthermore, I don’t think he’s suggesting that by reading (i.e., consuming) comments anyone is inhibiting others’ ability also to read comments. So I’ll refine the question: Does some people’s use of the comments section at the margin inhibit its use by others?

In some cases, the answer is clearly yes. Attention is the scarce resource. Some comments consume attention without contributing anything (or something sufficiently!) positive.

To understand where this problem occurs and how to solve it effectively, one first needs to understand that this is what is known as a first world problem. This is true in two senses. First, in the literal “people are dying of wars and poverty and famine and we are worried about blog comments?” sense. Second, and more importantly for our purposes, we ought to recognize that most bloggers do not sit around and worry about all the comments they are receiving. The median blog post gets zero comments. Most bloggers are concerned with trying to encourage, rather than inhibit, commenting.

The commenting dynamic is very different on small blogs than it is on popular blogs. On small blogs, people typically comment when they have something to contribute or ask that is relevant to the post. These are frequently of high quality (relatively speaking; recall Sturgeon’s Law: 90 percent of everything is crap). On more popular blogs, this positive commenting dynamic is confounded by the presence of eyeballs. Every post is read by many thousands of people. For the self-involved who could never attract such a large audience on their own, this is an irresistible forum for expounding pet hypotheses, axe-grinding, and generally shouting at or expressing meaningless agreement with the celebrity post-authors.

The first step, therefore, to higher quality comments is “be more niche.” Discourage your marginal readers with technical language, obscure references, and lengthy posts. Your marginal readers are not of high value anyway, and driving them away is an excellent way to improve the average comment of your inframarginal readers.

If you cannot bring yourself to do this, or you have delusions about being the next mainstream blog, then you must adopt some sort of rules to govern commenting. Because the incentives for commenting on blogs vary with the popularity and other characteristics of the blog, different blogs should use different rules to govern commenting (straightforward application of Ostrom 1990). Most smaller blogs probably do not need any sort of rules at all. My own blog, unpopular as it is, gets consistently high-quality comments with virtually no rules or policing. The comments section at the blogs of major media outlets (such as the New York Times), however, are a sewer. Again, there are too many eyeballs.

The kinds of rules that might be adopted are not particularly interesting in and of themselves. Many forums require registration to prevent fully anonymous comments. Pete mentions banning both anonymous and pseudonymous comments. Requiring users to log in with Twitter or Facebook accounts accomplishes basically the same thing. Users can rate comments and the better ones can float to the top. Commenters can compete for reputation or “karma.” I’ve opted not to do these things on my blog because I’d still prefer more comments, not fewer.

The structure of the comments themselves can aggravate the problem. For example, many sites are now using threaded comments, in which users can reply directly to another comment and the comments can be grouped together. While this may be fine for small sites, it is death to the comments section on bigger sites because it rewards the self-involved commenter with comments on his comments. It increases the payoff for piggybacking on the blog’s popularity.

As a final observation, I will note that banning comments is pretty nearly weakly dominated by unmoderated commenting. The reason is simple: if the comments are a sewer, then readers won’t wade in the sewer. The amount of time wasted reading bad comments is small relative to the value of the good comments, even if there are few good comments, because people ignore the comments sections on blogs with bad comments sections. I myself never read the comments on a post if there are more than 30 comments already, and rarely if there are even 20. This is a useful heuristic: if there are many comments, they probably aren’t any good. Banning comments doesn’t typically help and could possibly cause harm.

Comments are open.

The first scatterplot uses all available data.

It’s clear that there is a strong correlation between inflation means and variances (r=0.77, in fact) and an even stronger one, r=0.92, for means and standard deviations (see how the data appears to be quadratic?). But I don’t observe any evidence of clustering.

Because most of the data appears on the lower left, it may be helpful to zoom in. I repeat the plot for those countries where the mean is less than 150 percent. I also exclude the countries that have less than 15 observations.

Once again, there don’t appear to be discrete clusters. Just to make sure, let’s zoom in one more time on the lower left.

While Caplan’s proposed test does not support the Kling hypothesis, I am not sure that it effectively captures what Kling is postulating. For one, what counts as high and variable in the US is not the same as what counts as high and variable in Israel, Chile, Russia, or Zimbabwe. Secondly, if central banks have a choice between the two regimes as Kling postulates, then countries that spend time in both regimes are going to appear on the scatterplot in between the two hypothetical clusters (is this what we observe?). You can’t use a scatterplot of aggregated data to detect structural breaks. I’ll leave it to someone else (maybe one of my commenters?) to propose a better test.

Update: At Bryan’s request, here are three more graphs, zoomed in further on the lower left.

Let’s start with the most important question: why did Google decide to start being evil? People seem to actually be asking this childish question. The answer, of course, is that good and evil is not a useful framework for analyzing Google’s actions (though if they open concentration camps I will take this back). Google is motivated by profit. It faces incentives. I outlined Google’s strategy for profit-maximization in A Theory of Google. The basic conclusion of that post is that Google benefits from widespread, cheap, and high-quality access to the Internet.

If that’s true, then why doesn’t Google support net neutrality for wireless providers? <sarcasm>It’s almost as though they haven’t given this any thought.</sarcasm> Except that their chief economist is Hal Varian, who is one of the top scholars of the industrial organization of information-intensive markets and coauthor of one of the seminal books of the field, Information Rules. Varian and his fellow Googlers must have some reason to believe that net neutrality could hinder the development of the wireless Internet (though it appears not all of the rank-and-file are on board).

The first step to understanding the economics of net neutrality is to recognize the large fixed costs that accompany any network industry. The presence of large fixed costs means that the simple price-equals-marginal-cost condition for efficiency no longer applies. If all customers were charged MC, the firm would go out of business. It could not cover its large fixed costs. Even if the costs were sunk, the firm would “go out of business” at the margin, refraining from adding capacity on which it would only lose money. In general, large fixed costs imply that price and/or quality discrimination is a necessary feature of an efficient equilibrium (that is, if consumers do not all have identical demand). Read Michael Levine to see how this is the case even in competitive markets!

Another feature of industries with high fixed costs is that they tend to be monopolized or at least highly concentrated. Economists use the term “natural monopoly” to refer to those cases in which the monopolization is due purely to fixed costs and not to any coercive factor. In fact, traditional ISPs, in addition to being natural monopolies, are also coercively monopolized due to municipal franchises that grant them exclusivity. They therefore do not face even potential entry into their markets. A monopolist ISP might favor its own properties on the web, which is what worries net neutrality advocates. But if the monopolist ISP is free to charge whatever prices it wishes for its service, it can’t gain from pushing its own properties, or at least not at the consumer’s expense. Its incentive is to make the Internet as valuable as possible for its consumers so that it can maximize its profits on its monopoly. Remember the logic of double marginalization. If the municipal franchise results in regulated prices, then the monopolist ISP may have a strong reason to favor its own content. It leverages its monopoly position to reap profits through unregulated content rather than regulated Internet service.

A third factor intrinsic to Internet service is congestion. Transferring data on a network reduces the ability of others to do the same. This is a negative externality that can be remedied through a Pigovian tax, or better yet, through a Coasian solution. After all, property rights are well defined and transactions are already occurring. The externality can be resolved by a change in the terms of the contract.

The challenge, then, if you are socially benevolent, is to find a way (1) to efficiently incentivize investment in Internet service infrastructure, (2) to minimize the ill effects of the tendency of the industry to be monopolized, and (3) to reduce congestion, thereby making existing bandwidth capacity maximally valuable. This is not easy. The efficient solution would be something like the following. Consumers would pay for Internet service in two parts. First, they would pay an access fee, which varies from consumer to consumer in proportion to how much they value the Internet. Second, they would pay for the data they consume on a metered basis, with peak rates being higher than off-peak rates to efficiently allocate traffic. There would be no restrictions on the price or quality of service, though violations of service agreements would be prosecuted as fraud. Because the value of Internet service to consumers vastly exceeds the fixed costs associated with running an ISP, my intuition is that all monopolistic municipal charters should be abrogated and all markets contestable.

If that’s the ideal world, it’s not clear whether net neutrality brings us closer to it or further from it. Because we do not observe the ideal pricing structure, net neutrality regulations hamper firms’ ability to ease congestion by de-prioritizing what they believe is the lower-value traffic (remember, if optimal pricing exists, congestion is self-regulating). On the other hand, because some firms are coercive monopolies and face regulated pricing, net neutrality can improve welfare by taking away an inefficient monopoly rent.

Perhaps the most subtle way that net neutrality could be harmful is by aiding collusion between ISPs. If the firms have a sunk investment in infrastructure, regulations that make it more difficult to recover the value of new investments will discourage entry and expansion. Existing firms can carve up the current market and keep prices artificially high.

Google’s position, that traditional ISPs should be regulated and wireless ones should not, is defensible. Competition is more vigorous in the wireless sector than in the wired, and pricing is less regulated. Furthermore, the wireless industry is further from optimal capacity, so we ought to be sensitive to the incentives to invest.

I don’t mean to endorse Google’s proposal; rather, I wish to suggest that critics take the time to learn something about what it is they are criticizing. It’s dismaying to me that so many non-economists think they understand the effects of net neutrality. Skim some of TechCrunch’s recent posts on the topic: they are, frankly, asinine. It reminds me of a quotation from Murray Rothbard:

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

How did we get to this point? It’s the logical consequence of three decades of antigovernment rhetoric, rhetoric that has convinced many voters that a dollar collected in taxes is always a dollar wasted, that the public sector can’t do anything right.

I could easily write a thousand-word post refuting this claim, but that would just be more antigovernment rhetoric. Instead, I want to show you a picture. The data comes from the BEA’s NIPA Tables (3.1, 1.1.4, and 7.1).

If antigovernment rhetoric over the last three decades were as effective as Krugman claims, what would this picture look like?

I don’t care too much about the day-to-day politics of the War Diary, but what does interest me is NYU Journalism professor Jay Rosen’s observation that Wikileaks is the world’s first stateless news organization. Wikileaks is of course not literally free of state control; it operates out of Sweden. But the logic of the Internet is that if the Swedish government shuts Wikileaks down, it will move somewhere else. Moreover, Wikileaks is hosted by the same ISP that hosts The Pirate Bay, and they maintain backup servers at undisclosed locations. At least at currently-anticipated levels of government aggressiveness, Wikileaks can publish what it wants with impunity.

The Internet has elements of anarchy. Yet many businesses do not take advantage of the freedom the Internet affords. They choose, instead, to be subject to state law. This was initially puzzling to me. Why don’t all Internet businesses operate like Wikileaks, avoiding regulation and taxes imposed upon them by the state?

The answer, at least in part, is that some companies benefit from the credible commitment that an external enforcer enables them to make. Thomas Schelling makes this point:

Among the legal privileges of corporations…are the right to sue and the “right” to be sued. Who wants to be sued! But the right to be sued is the power to make a promise…a prerequisite to doing business.

Diego Gambetta, in his book on the Sicilian Mafia, also recognizes the value of buying protection against oneself.

This is why companies like PayPal (and its parent company eBay) don’t follow the Wikileaks strategy. Instead they happily make their headquarters and host their servers in the United States. If they get sued and lose the case, the US government will force them to pay up. And for the privilege of being forced to pay up, they abide by US regulations and pay significant sums in taxes. The ability to successfully sue PayPal is why so many of us fork over our bank account details to PayPal.

It’s tempting to think that as the Internet matures, governments will become increasingly irrelevant. Perhaps they still will. There are other mechanisms that can be used or discovered to credibly commit to honest dealing. Since information is transmitted rapidly and at low cost over the Internet, reputation mechanisms are appealing. But it is unlikely that governments will go away completely, even on the Internet. As long as some firms find government’s enforcement role to be worth the regulatory and tax burden, the virtual world will be tied to the territorial one.

Even if some companies choose to remain subject to government law, we can all benefit from the increased ability to opt out of the law, as Wikileaks has effectively done. If the cost of opting out fell to zero, Internet firms would bear the regulatory and tax burden only if the benefits of enforcement exceeded those costs. This would yield not only greater freedom of expression, but greater economic and personal freedom. To the extent that the Internet can be reengineered to be more decentralized, self-healing, encrypted, reputation-based, and so on, we can limit the pernicious effects of unwanted government involvement in commerce and communication.

In spite of this spending, urban public schools are usually terrible. There is no simple solution to this problem (read Bill Easterly — 1, 2 — and insert “learning” and “education” for “growth” and “development”), but reflecting on the exorbitant amounts of money on the table helped me focus on the incentive problems encountered by the education industry. I realized that similar problems have been solved by law firms.

Imagine that there are two kinds of performance measures. One loosely correlates with what it is that we want from our agents and is publicly verifiable. Because this performance measure is publicly verifiable, we can use it as a basis for writing contracts or regulations or whatever. The second performance measure correlates more strongly with what it is that we want, but is verifiable only by people with specialized skill, such as fellow-agents.

This describes the situation in both education and law. In both fields, there are simple metrics that are publicly verifiable that loosely capture what it is we want from workers. In education, examples are test scores and graduation rates; in law, it’s billable hours. Nevertheless, the attempt to rely on these metrics alone to motivate production are doomed to failure: they do not correlate closely enough with what we actually want, quality education or legal services. The incentives are to game the system, to teach to the test, to bill too many hours, etc.

Fellow-agents are capable of evaluating each other on another basis, one which by assumption correlates more strongly with what we want from them. Left to their own devices, they will shy away from doing so, because it is unpleasant to evaluate others, potentially hurting feelings and rocking the boat. This is the problem that law firms have solved. They have done so by organizing as partnerships. Because a partner’s pay is dependent on the quality of the work done by the other partners and employees, there is an incentive to engage in mutual monitoring to ensure that one’s co-workers are in fact doing quality work.

Would mutual monitoring work in schools? I think so. Teachers know who the other good teachers are. Because schools are typically run in a top-down fashion and answer to external authorities, there is an incentive to keep this information private. But if schools were organized on the law firm model and teachers could keep the surpluses generated by quality improvements, I predict that there would be a lot of quality improvements. A prerequisite for this approach is that quality improvements generate surpluses; schools organized on this model would need to be private.

The partnership approach to school organization would solve some other problems as well. First, much of the money spent on education today is captured by administrators. This is true in both private and public schools. The partnership form makes agents sensitive to the amount wasted on administration. This increases the resources available to actually educate people. Second, mutual monitoring will improve teacher quality in three ways: by discarding bad teachers, by motivating existing teachers to excellence, and by drawing new talent into a higher-paying profession. Higher quality teachers, with higher marginal products, will earn more pay in market equilibrium. To the extent that complaints about “low” teacher pay are valid, adopting the partnership form should address them.

When discussing incentive problems, economists often talk about the mistake of rewarding what is measurable at the expense of what you actually want, which is often not measurable. Incentives, that is, can be too strong. Test scores and graduation rates are measurable, and the results of attempts to enact measurement-based accountability in education have been disappointing. The insight of the literature on partnerships is that you can reward on the basis of quality dimensions that are not precisely measurable. Organizing schools as partnerships might have a significant effect on the quality of education they produce.

Kling’s post is particularly frustrating. It begins with the sentence:

I am not a soccer fan.

In my opinion, this should be the end of the post. If Kling does not appreciate soccer, can he not at least leave the several billion of us who do alone? If Kling feels six words is too short for a blog post, he can follow it up with this:

Therefore, I have no opinion on this game that brings joy to countless other people. Value is subjective, and I am happy to respect others’ subjective preferences.

If Epstein believes that his rule changes would improve the game, he should start his own modified soccer league and profit from its success. I would wish him the best of luck. But I am pretty sure he would not succeed, and that is because most of the world is basically happy with the way soccer works now.

As my regular readers know, I despise meddlesomeness. People should basically leave other people alone, particularly if they are not interested in receiving help or advice. However, I cannot resist the urge to engage in some retaliatory sports meddling, offered with my tongue implanted firmly in my cheek.

I am not a baseball fan. It’s too slow and boring. I propose some rule modifications borrowed from basketball and hockey. First, baseball needs something like a shot clock. I propose that no player (especially the pitcher) be allowed to hold the ball for more than five seconds, and that no more than 30 seconds should elapse between pitches under any circumstances. Violations of these rules will result in two minutes in the penalty box, and the defending team plays a man down. These modifications would not only increase the speed of the game, it would result in the elimination of fat people from professional baseball. Let’s face it—the fact that you can be both a fat slob and a successful baseball player is a damning indictment of the game.

Update — Kling, always a class act, tempers his claims: “…I gladly admit that my opinions should not count, since I know nothing about the sport.” He makes other interesting points in this new post, with which I mostly agree, addressing criticisms other than mine.

First, it will be cheaper for most people. With a flat-rate unlimited plan, carriers have to charge enough to cover the cost of average data use. This means that light users are subsidizing heavy users. Since there are many more light users than heavy users, most people will experience a decrease in their data fees.

Second, the plans will reduce congestion. Using a congestible resource like mobile bandwidth places a negative externality on other users of the service. Charging a fee for use is like imposing a Pigovian tax on any other negative externality. Just as properly-designed toll roads can reduce traffic, an efficient data charge will speed up the mobile web.

Third, and most importantly, limited data plans will provide incentive compatibility. They will put the carriers on the same side as consumers. With flat-rate unlimited plans, once carriers have you locked in, their incentive is to avoid investing in their network—to maximize profits by minimizing costs. But with a pay-per-use plan, their incentive is to improve their network so you will use more of it. With unlimited plans, their incentive is to disallow features such as tethering, which put additional strain on the network. With limited plans, they would want to make tethering as simple as possible, in order to get consumers to use more of their services. I think the improved incentives will make a major difference in the quality of service that consumers receive.

My prediction is that a year from now, AT&T and O2 customers will both experience better and cheaper networks and continue complaining about metered data plans. The least they could do is give some thought to the idea that the latter will cause the former.