Rockonomics: The economics of popular music

I really enjoyed my time in Seattle, and especially the Museum of Pop Culture. The plane trip from Seattle to Portland (which we also visited before returning to New Zealand) seemed an opportune time then to read this 2006 chapter (with the same title as this post) from the Handbook of the Economics of Art and Culture (ungated earlier versions here and here), by Marie Connolly and Alan Krueger (both Princeton).

That chapter had been sitting in my must-read pile for about ten years (!), but for whatever reason consistently kept getting bumped a little lower down the pile. It is important to me because the economics of popular music provides a lot of good illustrations of the things we teach in first year microeconomics. So given that ECON100 and ECON110 both start B Semester lectures next week, in this post I'm going to take some brief quotes (taken from the NBER working paper version of the chapter) from the chapter to illustrate some of the things we will cover in those papers.

Besides that, the chapter includes a lot of interesting detail on the structure of the music economy. Consider these bits, which relate to the ECON110 topic on media economics:

...it is clear that concerts provide a larger source of income for performers than record sales or publishing royalties. Only four of the top 35 income-earners made more money from recordings than from live concerts, and much of the record revenue for these artists probably represented an advance on a new album, not on-going royalties from CD sales... 

If a band composed its own music, it will also contract with a publisher to copyright the music... The publisher usually takes half the royalties, and the composer receives the other half (some of which goes to the manager).

...bands receive relatively little of their income from recording companies. Indeed, only the very top bands are likely to receive any income other than the advance they receive from the company, because expenses – and there are many – are charged against the bands advance before royalties are paid out...

Record companies tend to sign long-term agreements with bands that specify an advance on royalties and a royalty rate. The typical new band has very little negotiating power with record labels, and the advance rarely covers the recording and promotion costs, which are usually charged to the band. Because fixed recording costs vary little with band quality, only the most popular artists earn substantial revenue from record sales...

[Quoting Jacob Slichter, the drummer for Semisonic]: If our CD was sold in stores for fifteen dollars, the band’s share of the revenue might be something between fifty cents and a dollar per CD.

We cover moral hazard in both ECON100 and ECON110. Moral hazard occurs when one of the parties to an agreement has an incentive, after the agreement is made, to act in a way that brings additional benefits to themselves at the expense of the other party. In relation to that Connolly and Krueger write:

Caves prosaically notes that, “From the artist’s viewpoint, a problem of moral hazard arises because the label keeps the books that determine the earnings remitted to the artist.”

So, the recording label engages in moral hazard because it provides additional benefits to the label, and because the artists cannot easily monitor what the label is doing when it estimates earnings and costs and what should be paid to the artist. There are also a number of points that Connolly and Krueger write in relation to pricing (which we cover in ECON100), including:

As an economic good, concerts are distinguished by five important characteristics: (1) although not as extreme as movies or records, from a production standpoint concerts have high fixed costs and low marginal costs; (2) concerts are an experience good, whose quality is only known after it is consumed; (3) the value of a concert ticket is zero after the concert is performed; (4) concert seats vary in quality; (5) bands sell complementary products, such as merchandise and records...

The price of a concert ticket is set lower than it would be in the absence of complementary goods, because a larger audience increases sales of complements and raises revenue.

Firms that sell complementary products need not necessarily profit maximise for any of those products individually, if they can profit maximise across the whole range of their products. And in terms of price elasticity (covered in ECON100):

...despite flat or declining tickets sales, total revenues (in 2003 dollars) trended upwards until 2000 because of price increases. Other things equal, these trends suggest the elasticity of demand was less than 1 before 2000. Since 2000, however, there has been a 10 percent drop in ticket revenue for these artists, suggesting that prices increases have been offset by a larger than proportional demand response.

When demand is relatively inelastic, a given percentage increase in price is associated with a smaller percentage decrease in quantity demanded, so total revenues (price x quantity) increases. This is what happened prior to 2000, but after 2000 demand appears to have been elastic, so that the percentage increase in price was more than offset by a larger percentage decrease in quantity demanded, meaning that total revenues (price x quantity) decreased.

Connolly and Krueger cover inequality as well (as we will in ECON110):

...concert revenues became markedly more skewed in the 1980s and 1990s. In 1982, the top 1% of artists took in 26% of concert revenue; in 2003 that figure was 56%. By contrast, the top 1% of income tax filers in the U.S. garnered “just” 14.6% of adjusted gross income in 1998 (see Piketty and Saez, 2003). The top 5% of revenue generators took in 62% of concert revenue in 1982 and 84% in 2003.

And on intellectual property rights (which we cover in ECON110):

How far does intellectual protection go? Are rights strong enough to encourage the optimal amount of innovation? The problem stems from the fact that musical compositions are nonrival goods, whose property rights, as laid out by Nordhaus (1969), generate a trade-off between under-provision of the nonrival good (with weak rights) on the one hand and monopoly distortions (when the property rights are strong) on the other. 

Nordhaus's characterisation of the trade-offs inherent in intellectual property is one of the key pillars of the ECON110 topic on intellectual property rights. There are other bits of interest, including ticket scalping (which we cover in both ECON100 and ECON110), signalling (also both ECON100 and ECON110), and superstar effects (which we discuss in ECON110). A few parts of the chapter are a little technical, but all of it is interesting, and there are lots of gems to take away. Some parts of the chapter are getting a little dated, but mostly it has aged well and if you like to see economics in action, I encourage you to read it.