In my MRUniversity video on the economics of bundling I argue that bundling raises total surplus and that requiring the Cable TV companies to price by the channel is unlikely to reduce most people’s cable bill (see also Does Cable TV Ripoff People Who Don’t Like Sports?). Pragmatarianism offers an excellent critique. Here is one bit from a longer post worth reading in full:
The flaw in Tabarrok’s logic is that it completely ignores the necessity of determining what the actual demand is for the individual components in the bundle. For example, when I subscribed to cable…Charter had no idea how much I valued the Discovery Channel. Neither did the Discovery Channel. But is my valuation relevant? According to Tabarrok…it really isn’t. Uh, what?
How could the Discovery Channel and Charter and Tabarrok not care what the actual demand is for the Discovery Channel? In the absence of consumer valuation…how could society’s limited resources be put to their most valuable uses?
Tabarrok is basically arguing that we don’t need accurate information in order to efficiently allocate resources. Except, does he really believe that? Let me consult my magic database…
The most valuable public goods are constantly changing, just as the most valuable private goods are constantly changing. The signal provided by prices and mobility is therefore of great importance. - Alexander Tabarrok, in The Voluntary City
Huh. Hmmm. Is the Discovery Channel a private good? Yes. Is its value constantly changing? Yes. So…according to Tabarrok…it’s of great importance that the Discovery Channel should have its own price. But this sure wasn’t what he said in his video.
An excellent point that was made most forcefully by Ronald Coase in The Marginal Cost Controversy. Coase argued that pricing goods with high fixed cost at marginal cost would generate static efficiency but at the price of dynamic efficiency because we would not be able to say with assurance that the total value of the product exceeded total cost. Similarly we lose some information with bundling, perhaps especially so because marginal cost in this case is zero. With bundling, we know that the total value of the bundle exceeds the total cost but we are less certain that the total value of each bundle component (channel) exceeds the total cost of each component.
But this cannot be the whole story because in another paper, The Nature of the Firm, Coase pointed out that sometimes we choose not to use prices. Firms, for example, are islands of central planning in a market ocean (see Yglesias for a good discussion).
A channel such as HBO is itself a bundle of dramas, comedies and documentaries. Should Girls and Game of Thrones always be priced and sold separately and not through the HBO bundle? HBO certainly learns something from individually priced downloads on iTunes and that information helps HBO to improve its service. But how much is this information worth?
In 2002 should HBO have individually priced episodes of the Sopranos and sold them through AOL? Individual pricing generates value but it also has costs. Tradeoffs are everywhere. And, to the crux of the issue, if a law had been passed in 2002 requiring HBO to sell The Sopranos on an episode by episode basis would that have resulted in better and more programming at lower prices? I think not. Similarly, I see few reasons to think that welfare would be improved by a law requiring cable TV companies to price by channel.
More generally, the price system is embedded in the larger field of the market economy which includes non-price institutions such as firms; and the market economy is embedded in the larger field of civil society which includes non-profits and non-market institutions such as the family. Economists often focus on the virtues of the price system but that should not blind us to the many virtues and many margins on which a free society operates.