I. Introduction

I argue that digital piracy, on the individual level and within the specific context of compact discs (CDs) and digital versatile discs (DVDs), is motivated primarily by the relative price of purchasing an original item versus the costs of compiling an illicit version; therefore, corrective pricing and redistribution alone could significantly affect the decision to pirate and ultimately reduce the practice. To illustrate this hypothesis, I present a rough econometric model of how a consumer might price a homemade pirated copy of either a CD or a DVD; implicitly, I assume that CDs are the prevalent media for recording music and correspondingly, that DVDs are used to capture and store motion pictures. I argue that one solution to combating widespread fears about digital piracy is to correctly price the various inputs (costs of recording devices, blank media and software) as well as to encourage artists or producers to give added content [p180] or value to the original media. This added value I dub the “nouveau factor.”

My analysis focuses predominantly on the individual, the hypothetical homo economis but with a slight flaw. I assume that the individual is not engaged in widespread attempts to sell unauthorized copies of copyrighted works; the behavior I try to model is that of the tennis shoe pirate who copies a friend’s CD or downloads a movie off the Internet. The only legally meaningful distinction is that such behavior, while still a violation of the 1976 Copyright Act,[1] prosecution is less likely and, in the event of prosecution, the resulting remedies will be diminished. I am not focusing on widespread commercial piracy such as the mass manufacture of “bootleg” copies intended for retail sale where the courts impose nontrivial damage awards.[2] While this distinction is not profound, within the confines of my attempted economic model, I only address individual motivation because adding a for-profit element would require a different analysis.

II. Napster, the Pirate Generation and Feelings of Unfairness

“What is happening with global, peer-to-peer networking is not altogether different from what happened when the American colonists realized they were poorly served by the British Crown: The colonists were obliged to cast off that power and develop an economy better suited to their new environment.”[3]

In the closing decade of the twentieth century, the now infamous Napster began providing a file-sharing service that permitted users to download and exchange music over the Internet.[4] Napster’s humble origins [p181] were “the brainchild of a college student who wanted to facilitate music-swapping by his roommate[,]”[5] but, in the end “it [became] far from a simple tool of distribution among friends and family.”[6] Despite subsequent litigation, injunctions, and attempts to reach agreements with the aggrieved recording industry, [7] Napster ultimately fell from grace with the Internet community and was quickly replaced by a new breed of peer-to-peer software.

A new generation of software developed in the wake of the Napster lawsuits, [8] relied on a new and alternative method for its software that lacked the legal vulnerabilities of Napster. “Napster’s Achilles’ heel was [p182] that it retained a trace of the client-server model by depending on centralized software.”[9] However, successive software programs that vied for the now vacant throne, such as Kazaa, went to a client-server model that did not rely upon a central server or host sites. Instead, these new programs provided what is known as peer-to-peer service; there was no central computer server or centralized software of the sort that would give rise to contributory infringement claims. The litigation pending against Kazaa and other similar services will test the legal validity of the distinction between centralized and decentralized servers. Regardless of the ultimate failure of Napster, [10] the software gave voice and speed to a digital movement arguably termed either a revolution or a rampage. But the pyre of Napster, from whose ashes rose a whole new generation of software, began with a spark [11] — the MP3 file format.[12]

MP3 files facilitate the sharing of music because they significantly compress lengthy audio files that would otherwise take too long to transfer between users over the Internet; the format preserves the audio integrity of the original file but reduces the file size up to a factor of twelve.[13] Also, since MP3 files are digital copies, sound quality does not reduce for each successive generation of copy (an issue with analog copies). Pirates do not exclusively dominate the MP3 technology; many users choose to store legal copies of music on their computers or other listening devices, including the MP3 player. The capabilities of MP3 technology (and the formats in development that will inevitably replace it), when combined with the low price of home computers and recording devices, essentially motivate a new generation of entertainment consumer.

The popularity of Napster and its successors indicates a demand for file-sharing programs. Napster gave mainstream access to a new cultural “phenomenon” [14] — downloading music and movies off the Internet in [p183] order to produce a finished medium (be it a CD or a DVD) that substitutes for the original copyrighted work. Not only has the price of recording devices and media plummeted, but the access to free music and movies has greatly increased because of peer-to-peer software. This movement results in the piracy at issue in this Note. Napster and its kin represent more than a string of ones and zeros; they represent a sentiment that the entertainment industry overcharges for its services, or, from an even more idealistic viewpoint — that the industry should disseminate its information for free. Peer-to-peer software constitutes pirate’s sword to some, while to others, Robin Hood’s arrow.

The nouveau factor introduced here explains the zeitgeist which must force the entertainment industry to address the feelings of unfairness left in the wake of the peer-to-peer explosion and to implement proper pricing of the components of production for home copying (legal or otherwise). Either the entertainment industry can address these feelings by cutting retail prices or by attempting to add value to the retail versions of the product.[15] Failing this, they may face a variation of the ratchet effect. Typically, prices do not fall even when the cost of production falls, but this pricing structure may work against the entertainment industry. Individuals used to pirating CDs at a low price will resist going back to paying retail prices.[16] Therefore, there remains an incentive to create yet another peer-to-peer service, even if courts will swiftly shut it down. Each new technological innovation will test and stretch the boundaries of copyright law as programmers engage in a running cold war with the entertainment industry. [p184]

III. Copyright Protection: Shelter for Creators and Pirates Alike

The very laws that shelter artists and safeguard originality also create protection, or leave open loopholes, for potential digital piracy. The narrow scope of this analysis only concerns the unauthorized copying of music (sound recordings) [17] and movies (motion pictures) [18] on the individual level. For the individual end-user, the legality of copying music or movies onto another device or medium subsists in two exceptions; the “first sale doctrine” and the capacity for “substantial non-infringing uses” as defined by the court in Sony Corp. of America v. Universal City Studios, Inc.[19] “The so-called first sale doctrine originated in general English common-law rules of ancient ancestry disapproving restraints on the alienation of owned property. The right of alienation was viewed as a basic element of ownership. It was founded on policies favoring the free transferability of land and, more particularly, goods.”[20]

A copyright grants a property interest in the original expression embodied in a tangible medium,[21] but it does not necessarily [22] give the owner of the copyright the ability to “control the disposition of chattels in [p185] [another’s] lawful possession.”[23] The resulting tension results in the first sale doctrine as codified in the 1976 Copyright Act.[24]

Under the aegis of this doctrine, author Carl Hiaasen may own the copyright to “Naked Came the Manatee” and also possess the right to license a film based on the work. But, he may not stop anyone from selling their bona fide copy at a yard sale. By a similar token, a secondhand music shop can operate with impunity, [25] and libraries can loan out their copies. [26] But, in the digital age, courts have besieged the first sale doctrine: “Up to now, copyright law has focused primarily (though not exclusively . . .) on the physical, tangible copy as the basic unit of consumption and infringement, the main threat to the copyright owner. For the first time, digital technology is significantly challenging the very idea of a physical copy.”[27]

This Note does not address the merits of an actual first sale right to transmit digital copies on the Internet using “forward-and-delete technology.” [28] Rather, I examine two introductory questions that courts must resolve in the context of digital piracy. First, could an individual purchase a compact disc of the musical works of Shakira and burn a second copy of the original for use in a car? Second, could that user legally copy the songs onto a computer?

The 1976 Copyright Act, as amended by the Audio Home Recording Act, expressly permits these sorts of copying (making a CD to play on another device or transferring songs from a CD to a tape or vice versa) for noncommercial purposes. [29] Likewise, the amended Copyright Act [p186] expressly protects the right of a consumer to “back-up” computer software.[30] The rationale for this consumer protection is that

software is rarely run from the specific purchased copy; rather, software is commonly run from a copy that is installed in the hard drive of a computer. Thus, § 117 expressly privileges this type of copying. In addition, § 117 provides an express exemption for software owners from potential liability under MAI for merely running the software. Thus, the owner of a copy of software, even if not permitted to do so under any implied or express license, has the right to run that software as many times as he or she wants, even if this results in the creation of “copies” in the RAM of the computer. [This decision also] reflects a recognition that owners of software may have a legitimate need to create backup copies of software in case the original copy becomes destroyed or erased.[31]

By analogy, copying the contents of a disc (providing that this copy is “lawfully made” in the contexts of section 109(a) — this might exclude privately copying DVDs, [32] but would permit the sale of professional copies of the kind purchased at video stores) onto a personal computer for noncommercial uses would be presumptively legal. The key here is ownership of an original copy of the copyrighted material.[33] Where such [p187] ownership exists, “it appears that fair use acknowledges and gives some greater protection to certain uses engaged in by the owners of copies in the course of using such copies.”[34]

Sony Corp. of America v. Universal City Studios, Inc. provides legal protection to the instrumentalities of digital piracy; the recording devices, associated software, and even the blank media fall under the wide rubric of Sony. [35] Sony established the staple article of commerce doctrine to “strike a balance between a copyright holder’s legitimate demand for effective — not merely symbolic — protection of the statutory monopoly, and the rights of others freely to engage in substantially unrelated areas of commerce.” [36] As a result, Sony’s sale of the Betamax VCR did not constitute contributory infringement because other uses for the technology besides copyright infringement existed. This doctrine of substantial non-infringing uses protects “the sale of copying equipment, like the sale of other articles of commerce, [do] not constitute contributory infringement if the product is widely used for legitimate, unobjectionable purposes.”[37] The Sony court identified private, noncommercial time-shifting of television programs in the home as a valid use of the technology at issue.[38]

[p188] Under the holding of Sony, consumers may purchase CD-recorders, DVD-recorders, and blank media, as well as associated software programs, as long as consumers generally use those products for legitimate purposes; CDs and DVDs meet this minimal criteria.

The first sale doctrine in the digital age permits the public to copy CDs for certain purposes; likely even allowing storage on computers. Even before the technology existed, Sony established that companies could sell the latest CD-RW and bundle it with the best ripping and burning software available. Paired with inexpensive access to the Internet, particularly high-speed Internet, the current state of copyright law and its exceptions create an atmosphere of cyber-lawlessness. After all, the Internet has been called the wild west.[39] Not only may the public purchase legal and inexpensive recording devices and accessories but also over a dozen peer-to-peer services make available a widespread selection of digital music (facilitated by the MP3 technology and the practice of storing music on personal computers). Add to that the low risk of prosecution for piracy at an individual level and it is not hard to understand that Napster and its descendants posed a threat to the record labels. Clearly, something must change. Certainly, Congress could significantly change the substantive copyright law, perhaps adding draconian punishments for those individuals who engage in digital piracy. However, an economic analysis charts a different course based on consumer consumption models, individual decision making functions, and proper pricing of inputs, as well as addressing more intangible notions such as consumer perceptions of fairness.

IV. Economic Analysis of the Incentive to Pirate

Digital piracy’s illegality has little impact on the individual decision-making function.[40] While this outcome may surprise some, it would not [p189] shock an economist. A simple behavioral model of this type of conduct (with the usual economic assumptions) [41] reveals the copyright laws’ shortcomings. An individual discounts the value of the expected punishment because the risk of prosecution for piracy (R_p) is low (both objectively low as well as subjectively low since individuals may further underestimate the probability of being caught). [42] Taking into account all physical costs (C) associated with making the copy and assuming the punishment consist of a fine (F), then the cost of a pirated CD (P_copy) is:

P_copy = (F * R_p) + C

Yet, if the punishment consists of a jail sentence (J) (measured in years) then the analysis takes into account opportunity costs and lost value of future earnings. Accounting for lost wages per year (W) and all physical costs (C) associated with copying, the cost of the pirated CD (P_copy), discounted to the present value using the interest rate (r), would be:

P_copy = [(J * W) * R_p + C] / (1+r) J

Making the CD or DVD becomes a costly endeavor. Still, for either fine or punishment, the rational customer purchases this illegal copy as long as P_copy < P_authentic (the consumer may choose either the copy or the original when faced with equality of prices).

These two simple models illustrate the deterrent effect of punishment and the probability of detection on the cost-benefit analysis behind the decision to commit digital piracy. Implementing an extremely effective method of enforcing laws or creating harsh punishments for the few individuals prosecuted for piracy would effect the individual decision making process. But, based on the following economic analysis, I propose a different solution from the usual detection/punishment dichotomy.

The basic models presented above sketch the process I analyze, specifically the decision making function of a potential copyright infringer. But the heart of my Note describes a more accurate model of the decision to pirate. I present a cost function model for a pirated copy in Equation 1. Keep in mind the rational consumer will “buy” the [p190] pirated copy when its costs less to make it than to purchase an authentic copy (P_copy < P_authentic).

Equation 1

P_copy X = β P_m + [(β P_r)/x] + T(Wα) + N

P_m = price of blank media
P_r = price of recording devices
N = the nouveau factor (a constant used to explain residual value of an authentic copy)
W = wages per unit time (opportunity costs)
T = time it takes to make a copy including search costs
β = a time weighting factor indicating a decrease as a function of time
α = a time weighting factor indicating an increase as a function of time
X = the number of copies made on the same device (depreciating the initial cost of purchasing the recording device over the total number of copies made)

The prices of the blank media as well as the recording devices decrease as a function of time (they get less expensive to purchase as more are produced, etc). The consumer must pay a substantial initial purchase price for the recording device, but the total number of copies made previously discounts the cost of producing any given copy. Given the current state of technology, β, P_m, and [β‚ P_r)/x] will fall as a function of time and as a function of the quantity of copies produced (consider the impact of bulk purchases on the price of blank media). In fact, if the consumer takes the limit of Equation 1 with respect to time (β), the value of β, P_m, and [(β P_r)/x] falls to zero.

While the price of inputs fall towards a fixed rate, opportunity costs do not fall. In fact, since wages tend to increase as a function of time (at the very least, they increase enough to offset normal inflation that would drive up the costs of P_m and P_r) T(Wα) will increase as a function of time. So, given an examination of Equation 1 over time, T(Wα) emerges as the relevant variable group for analysis. If wages lost during the time it takes to create a copy exceed the cost of an original copy, then the rational consumer will purchase the effectively cheaper original. Teenagers may have embraced services like Napster wholeheartedly because of these comparatively low opportunity costs, including their low earning potential, and that they attach a relatively lower value to their leisure time (since they have more of it). The classic labor/leisure tradeoff suggests that older [p191] people with typically greater opportunity costs (less spare time due, in part, to work and a higher wage rate) do not find it cost-effective to pirate software, even with inexpensive blank media and hardware. So, while some find raising the hourly wage an attractive proposal, I do not see it as a logical method to reduce the incentive to make unauthorized duplicates of copyrighted works. Fortunately, Equation 1 suggests several other courses of action.

Consider the β P_m + [(β P_r)/x] segment of Equation 1; these describe the price functions of the raw factors of production. If inputs (blank media and recording devices) cost more and a sales tax maintained the higher price, [43] the market would create an effective price floor for copies. For example, if blank CDs cost five dollars, this would effectively subtract five dollars off the price of an authentic copy, assuming a tax-exempt or tax-preferred company produced the authentic copy. On one extreme, no one would have an incentive to pirate if blank media prices exceeded the price of authentic copies. Ideally, the tax revenue from artificially buoying the price of the inputs should not go to the producers of the inputs; rather, the revenue should go to compensate copyright holders who may lose sales volume to piracy or other inhibition costs. [44] While this may seem attractive to some, inflating prices in this manner has its drawbacks. Unfortunately, these higher post-tax prices would exist even for non-infringing uses and the higher prices would have a chilling effect on legitimate endeavors.[45]

The nouveau factor constitutes a straggling variable in Equation 1. However, the nouveau factor represents a way to substantially deter piracy. Observing the contrast between the presentation of old vinyl records compared to compact discs inspired the development of the nouveau factor. Furthermore, companies now sell a new generation of compact discs that include extras such as photographs, interviews, and video clips. DVD versions of films frequently offer extended scenes, director [p192] commentaries, and other material beyond the scope of the underlying motion picture.

A marketable segment of the consumer population considers the presentation value of the records or the new enhanced discs higher than the other formats; the music remained the same, but the art and the added lyrics and photographs enhance the experience. Consumers feel they get more than just the music; as one record enthusiast put it, he enjoys the experience of opening and playing a vinyl record. If artists add the nouveau factor to their works and the retail price remains the same (granted artists must identify and define the elements of the nouveau factor which is an inexorably link with the creative process itself), they would add value to the product beyond the mere sound recording or motion picture the consumer has purchased.

Finally, the industry could mandate a decrease in the retail price of music and movies, effectively lowering P_authentic and swinging the purchasing decision back towards authorized copies. While this may not seem like an attractive proposal to the current industry, it would certainly decrease the incidents of piracy and help producers recover plundered profits. In the best-case scenario, producers would recoup the sales lost to piracy and the lower retail prices would result in higher demand and subsequent sales. Certainly, the entertainment industry and their lobbyists would resist this scenario and would meet it with tremendous rent-seeking efforts. As a result, prohibitively high transaction costs associate with this proposal.

If the recording industry would combine an increase in price of inputs (with the profits ideally going to the copyright holders), more and varied content to accompany the core copyrighted material, and a moderate decrease in the retail price of the copyrighted material an intriguing solution results. The industry must make the price of the original copyrighted product closer to the costs of producing a pirated copy and they must ensure that the original has some added bonus, the nouveau factor, which a pirated version cannot loot.

V. Conclusions

Copyright law does a remarkable job of protecting many forms of creative efforts; however, the digital age has raised definite problems for protecting music compositions and sound recordings. Considering the general apathy towards individualized acts of piracy and the widespread use of file-sharing programs such as Kazaa, statutory revisions would not adequately curb illegal copying. At the same time, general criticism would [p193] result if Congress passed a set of laws that made most of the general public into criminals because the government would undermine the legitimacy of law. Recognizing that legislative action will not, as of now, realistically solve what I call tennis shoe pirates, we should turn to economic attempts for deterrence.

Opportunity drives piracy; piracy requires low opportunity costs coupled with a low probability of incurring any serious legal consequences. In analyzing the rudimentary production functions presented in this Note, neither steep fines nor serious jail time would effectively curb piracy. The general belief of economic theory postulates that individuals not only do not objectively perceive the probability of prosecution, but individuals also subjectively discount the likelihood of their own prosecution. Therefore, relying on the probability of detection to discount the expected value of an act of piracy flaws the deterrence models. I favor the economic model proposed in this Note, where taxation holds the factors of production (e.g., blank media) artificially high. Coupled with a move by the recording industry to reduce the price of retail products as well as a move by artists to add bonus material or presentation value to their work, the value of an original work will increase. As a result, the industry can achieve the equilibrium solution where the authentic copy costs the same or more than the pirated version. Lower prices result in greater sales for retail copies which allows the tax revenue from sales of factors of production to offset losses suffered by artists and the recording industry.

Ideally, in the end producers receive at least the same amount of revenue as before and piracy motivates fewer consumers. While such a condition does not result in Pareto optimality, such a solution seems impossible. I firmly grounded the model presented and argued for in Kaldor-Hicks efficiency where the market deliberately strips the gains of pirates and uses them to compensate the losses of artists and their industries. Certainly I recognize the difficulty in administering some elements of the solution proposed. Specifically, the tax on factors of production requires extensive study to determine the ideal price; as does the elasticity of demand for consumers as well as for businesses so as not to have a chilling effect on purchases. While I call for a bifurcated price structure (one for individuals and one for businesses with valid tax identities) I acknowledge that this would create an incentive for arbitrage; and, a sudden and drastic increase in the price of blank media would significantly benefit consumers who have large “stock piles.” Despite the potential problems, I still support an economic deterrence model as a means of curbing digital piracy; I strongly urge that any model or proposal [p194] focus primarily on the factors of production and the nouveau factor rather than the usual expected value analysis.