Screening in digital monopolies

TL;DR

This paper examines how digital monopolies screen quality levels in markets where digital goods can be replicated at no cost, revealing inefficiencies in investment and distribution that are affected by competition.

Contribution

It introduces a model of quality-based screening in digital markets where production costs depend on the highest quality, highlighting two key inefficiencies and the impact of competition.

Findings

Monopolists underinvest in high-quality digital goods.

Certain buyers receive degraded versions due to distributional inefficiencies.

Competition worsens productive inefficiency but improves distributional outcomes.

Abstract

A defining feature of digital goods is that replication and degradation are costless: once a high-quality good is produced, low-quality versions can be created and distributed at no additional cost. This paper studies quality-based screening in markets for digital goods. Production costs depend only on the highest quality supplied, unlike in standard screening models. The monopolist allocation exhibits two interdependent inefficiencies. First, a productive inefficiency: the monopolist underinvests in the highest quality relative to the efficiency benchmark. Second, due to a distributional inefficiency, certain buyers receive degraded versions of the produced good. Competition exacerbates productive inefficiency, but improves distributional efficiency.