Classroom Companion: Business

 
Chapter 6 · Digital Goods and Services

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6
or Android. Some of them are very simple digital services that have been developed 
by a single person over a relatively brief timeframe.
An interesting example is telecommunications networks. It costs billions of US 
dollars to build and run these networks. On the other hand, the networks transport 
several exabytes (10
18
bytes) of information each second so that the cost per byte is 
negligible, several magnitudes smaller than a cent. Hence, the marginal cost for 
sending an additional message over the expensive telecommunications infrastruc-
ture is, for all practical purposes, zero. The marginal cost of telecommunications 
services is thus zero, and the pricing of telecommunications services cannot be 
based on usage.
High fixed costs do not always mean that the consumer must pay for the good. 
This depends on the business model of the company. The running costs of 
Facebook and Google are very high. These costs are not covered by direct pay-
ments from the consumers but, indirectly, by selling advertisement space. This is 
made possible by collecting huge amounts of personal data from the users and 
selling these data to marketers for targeting the advertisements or to other data 
processing corporations using them for other purposes. Such business practices are 
subject to obvious privacy concerns.
The relative gap between fixed and marginal costs is descriptive for digital 
goods. For example, the major cost of an app is the development of the app. The 
time taken to develop an app can be anything from a few days to several years. As 
we have seen, the marginal cost of a digital good (e.g., the app) is zero so that the 
cost of installing the app is also zero, and every new sale of the app contributes 
directly to revenues. Copies of the app can even be distributed for free without any 
financial loss for the developer. When total sales have matched the costs of devel-
oping the app, the remaining sales are pure profit.
Under these conditions, the average cost of a copy of the digital good equals:
AC
F
n
MC
F
n



,
where AC is the average cost, F is the fixed costs, n is the number of copies of the 
good produced during its lifetime, and MC is the marginal cost. 
.
Figure 
6.3
shows the average cost as a function of n. Observe that the average cost approaches 
zero as n gets large.
Economies of scale are the cost advantages that companies obtain as the num-
ber of units produced increases. This is so because the fixed cost per unit decreases 
as the production volume increases as shown in 
.
Fig. 
6.3
 and may tend to zero if 
the number of units produced is large. Companies producing physical goods ben-
efit from cost advantages as the number of units produced increases only up to a 
certain point. The marginal cost per unit produced is independent of production 
volume and sets a lower limit for the cost of the product. Moreover, expanding the 
production beyond a certain threshold may also necessitate that more production 
infrastructure must be built, thereby increasing the cost of administration and 
support- functions so that the benefits from economies of scale are marginalized. 
This is different in the digital economy. This is so because the marginal cost is zero 
and that there is no limit to the number of units that can be produced without