Why Libraries Exist

Imagine a world in which you share every book you buy with nine strangers, and you don't buy nine of every ten books you read. What would that world be like?

If you're a librarian, you're probably thinking it would be a reader's paradise. If you're a publisher, you're probably thinking it would be an author's nightmare. If you're an economist, you're probably computing demand curves, and concluding that both librarian and publisher have got it completely wrong.

Demand curves are used by economists to characterize the market for products. They plot the the amount the market would buy for a given price. For example, the market for a book would show that many people will buy books at a low price, and few will buy the book if it has a high price. If you are an exclusive seller in a market, as most publishers are, you can choose any price you like, but your revenue will be maximized if you choose a price somewhere in the middle of the curve. For the demand curve shown, the best price for the book is $10, which results in 1000 sales, for a revenue of $10,000.

What happens to the demand curve in our hypothetical everybody-shares world? The sales go way down of course, but the people willing to get the book for $1 will get to read books priced at $10. The people willing to spend $10 will be able to read the book even if it's priced at $100.

If the publisher took economics in college, he would look at the demand curve and price the book at $100 instead of $10, and guess what? The publisher revenue would be $10,000, or exactly the same as before! Since the publisher doesn't have to incur the printing costs of the larger print run, he makes more profit.

Is this realistic? Librarians can't have missed the fact that books meant for the library market are invariably priced at five times what the book would command in the trade market. On the other hand, if publishers were better at math, well... they'd have become bankers, and we'd probably all be better off in 2010 than we are!

The real world makes things complicated, and economists like UC Berkeley's Hal Varian studied these situations in the 90's. They wrote lots of interesting articles, including ones filled with math (pdf) and others fit to be read by librarians and publishers. Varian included the effects of transaction costs, production costs and the different values of owning and sharing, and found that library-like sharing benefits both publishers and consumers when the transaction cost of sharing is less then the marginal production cost:

1) more books will be read; 2) consumers will pay a lower price per reading; 3) the sellers will make a higher profit; and, 4) consumers will be better off.

To put it another way, libraries can be economically justified if the cost to lend a book is less than the cost to produce and sell a book. As I discussed in my previous article, the Institute of Museum and Library Services publishes a survey (available here) that tells us that US public libraries performed 2.17 billion circulation transactions in 2007 at an operating cost of $8.86 billion dollars. If we ignore all the other services that libraries provide, that gives us a cost per transaction of $4.09. So public libraries are inherently beneficial if it costs more than $4.09 for publishers to make, sell, and deliver an extra book.

Varian also notes that consumer sharing also yields benefits when consumer preferences are heterogeneous. Some people want to read the book the day it comes out; other people are perfectly happy to wait until the paperback comes out, and others will prefer to get it from the library. This heterogeneity allows market segmentation, which improves the efficiency of the market. The book publisher can charge $30 for the hardcover edition, but can still make money off of people who are only willing to pay $10 by issuing a paperback a year later. The publisher even makes money from library sales that allow use by people not willing to pay anything for book!

Libraries benefit society in many ways, but it's important for both publishers and librarians to understand the economic role that libraries have played in the book industry- they benefit everybody, publishers, authors and readers, by aggregating demand and helping to segment the market.

Next... ebooks.