Thursday, June 22, 2006

Textbook Economics

A student asks an intriguing question about what happens when professors sell the free examination copies of textbooks they get from publishers:

Dear Professor Mankiw,

I am an undergraduate student currently taking a course on Principles of Microeconomics. The required textbook for the course is the fourth edition of your Principles of Microeconomics, which I have immensely enjoyed reading.

However, a NOT FOR SALE note on the back cover of the instructors edition of the book caught my eyes when I happened to see it on my professor's desk. The note reads:

This textbook has been provided free for an instructor to consider for classroom use. Selling free examination copies contributes to higher prices of textbooks for students.

This seems to contradict the analysis of changes in equilibrium that is introduced in your textbook and was discussed in our class. According to what I have learned about analyzing changes in equilibrium, I believe that selling free examination copies shifts the supply curve to the right, thus reduces (rather than increases) equilibrium prices and increases equilibrium quantity. Therefore, all else being equal, selling free examination copies DOES NOT contribute to higher prices for textbooks for students.

Professor Mankiw, would you please let me know if my analysis is correct? If so, would it not be desirable that the publisher remove or revise the NOT FOR SALE note from the instructors edition of your textbook for economics majors? It might not matter in the case of textbooks other than economics textbooks, but it can confuse economics majors.

If my analysis is incorrect, I would appreciate your step by step explanation of how so.

Note that I do not wish to encourage anybody to sell free instructors examination copies. I put this matter to you only in respect to the economic principles involved.

[name withheld]

I do not view the textbook market as well described by the model of perfect competition that underlies supply and demand curves. It is much closer to the world of monopolistic competition. Fixed costs are high, marginal costs are low, and products are differentiated. In equilibrium, price is well above marginal cost, and there is free entry, which dissipates economic profits.

How does the sale of free examination copies affect this kind of market? It is a hard question. The person at the publisher who wrote that warning probably reasoned that the sale of the free examination copies by professors would reduce the company's sales, that fewer sales would drive up average costs (remember those large fixed costs), and that higher average costs would have to mean higher prices in the long run.

The story, however, is not that simple. The initial impact is of the sale of the examination copies to reduce profitability. Because lower profits discourage entry, there are fewer products in equilibrium. Fewer products would mean reduced variety and a larger market share for those products that do exist.

The hard part is figuring out how a smaller number of products translates into prices and consumer welfare. Less variety is certainly bad for consumers. Some "niche" books (for small courses, for example) might not exist at all. Fewer products could also mean less competition and higher prices, although I could imagine that this need not be the case. It would seem to depend on the form of the demand curve and the nature of post-entry competition. One would have to write down a formal model to figure it out.

Here is an analogous situation: If a person makes bootleg copies of movies and sells the pirated DVDs, is he making consumers better off or worse off? In the short run, consumers might enjoy lower prices, but because making movies is now less profitable, fewer movies are made, and consumers most likely end up worse off in the long run. The economic forces at work when professors sell their free examination copies are similar.

If you don't believe that examination copies of textbooks and bootleg copies of movies are the same, change the bootleg copies into free examination DVDs given to theater owners to help them decide which movies to show. Does it really matter how the free copies get out into the marketplace? Maybe from a legal standpoint, but probably not from an economic standpoint.

Of course, I am not a disinterested player in all this. So think it through yourself. Do these arguments make sense? Comments even more welcome than usual.