Classroom Companion: Business

E-bank
service
Authentication
service
. Fig. 6.2 E-banking. (Authors’ own figure)
6.1 · Definitions

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Digital goods and services do not degrade as a function of time—they will con-
tinue to exist far into the future with the same quality as when they were created 
because of their digital nature. This is different from physical goods which nor-
mally degrade over time.
For simplicity, we will hereafter use the term “digital goods” instead of “digital 
goods and services” if the meaning is clear from the context.
6.2 
 Zero Marginal Cost
A key characteristic of digital goods is that they have zero marginal cost. Digital 
goods can be reproduced with no additional cost.
Definition 6.3
Marginal cost is the cost of producing one additional unit of a good or service. 
Digital goods and services have zero marginal cost.
Let us estimate the cost of producing one additional copy of an app. If the app has 
been downloaded and installed, say, 10,000 times on different smartphones, what is 
the cost of the next download? In a networked system, the app software is down-
loaded from the app server and transmitted over the Internet to the smartphone 
where it is installed. There are certain costs associated with these operations, for 
example, a small amount of electric energy is required for processing the app in the 
server and installing it in the smartphone. Similarly, there are some small costs 
associated with sending the app software over the Internet (amount of electric 
energy consumption per message and the share of fixed costs associated with send-
ing a single message over the network). These costs are tiny so that, for all practical 
purposes, the cost of installing one additional copy of the app is zero.
Repeating the same arguments, we again conclude that the costs of processing 
an extra trade transaction on Amazon, posting a new message on Facebook, or 
downloading a video on YouTube are zero.
On the other hand, the marginal cost is not zero for physical goods. The cost of 
production then includes the cost of raw materials (e.g., steel or plastic), workforce, 
and logistics. Note that some e-commerce businesses selling physical products 
online, such as Amazon, do not have zero marginal cost because of the shipping of 
the physical goods. However, the marginal cost of the digital trade transaction is 
zero.
Digital goods may have high fixed costs since some of them are expensive to 
develop, build, and operate. The development of software may cost millions of US 
dollars, require development teams with hundreds of people, and take several years 
from idea to finished product. The development of the computer game Grand Theft 
Auto V (released in 2013) cost $265 million, while Star Wars: The Old Republic 
(released in 2011) cost more than $200 million (List of most expensive video games 
to develop, 
2020
). On the other hand, there are examples of digital goods with low 
fixed costs, for example, the computer game Minecraft and many apps for iPhone