Question

Software has historically been an artificially scarce good-it is nonrival because the cost of replication is negligible once the investment to write the code is made, but software companies make it excludable by charging for user licenses. But then open-source software emerged, most of which is free to download and can be modified and maintained by anyone. a. Discuss the free-rider problem that might exist in the development of open- source software. What effect might this have on quality? Why does this problem not exist for proprietary software, such as the products of a company like Microsoft or Adobe? b. Some argue that open-source software serves an unsatisfied market demand that proprietary software ignores. Draw a typical diagram that illustrates how proprietary software may be underproduced. Put the price and marginal cost of software on the vertical axis and the quantity of software on the horizontal axis. Draw a typical demand curve and a marginal cost curve \((M C)\) that is always equal to zero. Assume that the software company charges a positive price, \(P,\) for the software. Label the equilibrium point and the efficient point.

Short answer

Answer: Part a: The free-rider problem in open-source software development occurs because individuals can use or modify the software without contributing to its development, which may lead to a lower overall investment in the project. This can impact the quality of the software in different ways, as a lack of funding could lower the quality, while the collaborative nature might improve it. The free-rider problem does not exist in proprietary software because companies charge for licenses, funding development and improvements. Part b: Proprietary software may be underproduced where the charged price is above the marginal cost, which is equal to zero. The difference between the equilibrium point (point E) and the efficient point (point A) represents underproduction, as there is unsatisfied demand at a lower price. The efficient allocation of resources occurs at point A, where the price matches the marginal cost.

Step-by-step solution

Part a: Discussing the Free-Rider Problem in Open-Source Software

The free-rider problem can occur in the development of open-source software because individuals can benefit from using or modifying the software without contributing financially or by improving the code. This might lead to a lower overall investment in the development of the software, as there is no incentive to pay for a product that can be used for free. The effect on the quality of open-source software could vary. On the one hand, the lack of revenue might lead to fewer resources being invested in the project's development, resulting in a lower quality product. On the other hand, the collaborative nature of open-source software could lead to a larger number and diversity of contributors, who can provide different ideas and skills to improve the software's quality. This free-rider problem does not exist for proprietary software because companies like Microsoft or Adobe charge for user licenses, making their software products excludable. By charging for the software, the developers generate revenue that is used to fund further development and improvements to the software, ensuring a continuous increase in quality.

Part b: Diagram Illustrating How Proprietary Software May Be Underproduced

In order to represent graphically how proprietary software may be underproduced, we will draw a diagram with the price and marginal cost of software on the vertical axis and the quantity of software on the horizontal axis. 1. Draw the demand curve, which will slope downwards from left to right, showing that the quantity demanded decreases as the price increases. 2. Draw the marginal cost curve, which will be a horizontal line at zero, representing the negligible cost of replicating software once it is developed. 3. Label the price charged by the software company as \(P\) on the vertical axis. Draw a horizontal line from this point to intersect the demand curve. Label the intersection point as equilibrium point (E). 4. Label the efficient point (where the demand curve intersects the \(MC=0\) curve) as point A. The underproduction of proprietary software is represented by the difference between the equilibrium point (E) and the efficient point (A). At point E, the price of the software is above the marginal cost, meaning that there is an unsatisfied demand for the software at a lower price. Point A represents the efficient allocation of resources, where the price corresponds to the marginal cost.