CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

CBO

PAPER

AUGUST 2004

Copyright Issues

in Digital Media

The Congress of the United States O Congressional Budget Office

CBO

Copyright Issues

in Digital Media

August 2004

A

PAPER

Preface

Rapid technological progress in information technologies poses new issues for copyright law. Today, a digital file can be copied and instantaneously distributed worldwide 

through the Internet, thus potentially depriving the copyright holder of revenue from licensed 

sales. As a result, holders of copyright on creative works in digital format are contesting the 

right of consumers to make personal copies of copyrighted materials. At the same time, consumers are beginning to chafe at copyright owners’ use of digital technologies to prevent or 

deter copying and other unauthorized uses of copyrighted works.

As digital processing grows more powerful and the high-speed distribution of digital content 

becomes more pervasive, the debate over copyright issues—in particular, whether copyright 

law has achieved the appropriate balance between incentives to engage in creative activity and 

the social benefits that arise from the widespread use of creative works—is likely to intensify. 

Yet the implications of any change to copyright law extend beyond the producers and consumers of copyrighted material to society at large. Investments in the computer hardware and 

communications industries, for example, are linked in part to the availability of creative content in digital form. How the current copyright debate is resolved, therefore, is likely to influence the growth of those related sectors of the economy. Potential revisions to copyright law 

may also have an impact on broader social concerns such as individual privacy.

Revisions to copyright law could impose mandated costs on producers and consumers of 

copyrighted material, as well as the providers of goods and services used in conjunction with 

copyrighted works. This Congressional Budget Office (CBO) paper reviews current copyright 

law in the United States and considers the unique aspects of digital technology’s challenge to 

that law. It also examines the prospects for a market-based resolution to copyright disputes 

over digital content and explores the effect of potential revisions to copyright law on economic efficiency and equity. While this analysis suggests some issues and concerns that the 

Congress may wish to consider during its deliberations about any changes in copyright law, in 

keeping with CBO’s mandate to provide objective, impartial analysis, the paper makes no 

policy recommendations.

Nathan Musick of CBO’s Microeconomic and Financial Studies Division wrote this paper 

under the supervision of Roger Hitchner and David Moore. Helpful review and comments 

were provided by Robert P. Murphy, CBO’s General Counsel; Julie H. Topoleski of CBO; 

Robert M. Hunt of the Federal Reserve Bank of Philadelphia; and Robert Kasunic of the U.S. 

Copyright Office. The assistance of external reviewers implies no responsibility for the final 

product, which rests solely with CBO.
iv COPYRIGHT ISSUES IN DIGITAL MEDIA

Juyne Linger edited the paper, and Christine Bogusz proofread it. Angela McCollough prepared the tables and graphs. Maureen Costantino designed the cover, produced the figures, 

and prepared the paper for publication. Lenny Skutnik produced the printed copies, and 

Annette Kalicki prepared the electronic versions for CBO’s Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

August 2004
Summary vii

1 The Current Copyright Debate 1

Disputed Control of Copyrighted Works 1

New Obstacles to Copyright Enforcement 2

Potential Impact of Copyright Law Revisions on Innovation and 

Economic Growth 3

2 Copyright Law and Technological Change 9

The Rights of Copyright Holders 9

Limitations on the Rights of Copyright Holders 9

Unsettled Areas of Copyright Law 11

Copyright Law Modifications for Digital Media 11

Technology’s Continuing Challenge to Copyright Law 14

3 Copyright and the Economics of Intellectual Property Regulation 21

The Regulation of Intellectual Property 21

More Efficient Copyright Markets: Price Discrimination

and Technology 23

4 Economic Implications of Prospective Legislative Action 27

Forbearance 27

Extend Compulsory Licensing to Digital Content 33

Revise Copyright Law 34

CONTENTS
vi COPYRIGHT ISSUES IN DIGITAL MEDIA

Table

4-1. Primary Effects of Broad Options for Modifying Digital Copyright Law 28

Figures

1-1. Distribution of Gross Revenues Across Core Copyright Industries, 2002 4

2-1. Annual Change in Value of Recording Industry Shipments,

1987 to 2003 19

Boxes

1-1. Interpreting Gross Revenue Data 5

2-1. Protection Afforded to Collections of Facts 10

2-2. Recent Legislative and Judicial Responses to Copyright Issues

Arising from the Digitization of Creative Works 12

2-3. Is It Legal to Use a Computer to Make a Copy of a Music CD? 15

2-4. A Particular Technology’s Challenge to Fair Use 16

2-5. Peer-to-Peer File-Sharing Networks 18

4-1. Internet File-Sharing: Trends and Attitudes 30
Summary

Historically, U.S. copyright law has sought to balance private incentives to engage in creative activity with 

the social benefits that arise from the widespread use of 

creative works. In the past, the emergence of new technologies—the photocopying machine and videocassette 

recorder, for example—has threatened to tilt the scales of 

the copyright regime by loosening the control that copyright owners enjoy over subsequent uses of their works. 

Such a development could reduce the revenues that creators of copyrighted material obtain from their efforts 

and thereby restrict the future supply of creative works. 

Over the years, however, three important factors have 

helped to preserve some balance in the U.S. copyright regime: the judicial interpretation of existing copyright law; 

the enactment of new legislation; and the ability of copyright holders and the industries that market and distribute creative products to find ways of applying those new 

technologies to generate sufficient returns to maintain the 

flow of new creative works.

An economically efficient outcome in markets for creative works is elusive. Efficiency in markets for goods and 

services generally requires that the cost of producing the 

last (or marginal) unit must equal society’s valuation of it. 

However, once a copyrighted work has been created, relatively few costs are incurred in its reproduction and distribution—especially if the work is in digital form. Offering a creative work at the relatively low marginal cost of 

reproduction and distribution, therefore, would not generate the returns needed to recoup the overall expense of 

supplying it. To encourage creative works, copyright law 

has traditionally allowed for licensing rights that enable 

pricing above marginal cost, while placing a limit on the 

scope and duration of copyright protection to ensure that 

creative works eventually become widely available. Copyright law therefore accepts some static inefficiency (copyrighted works are typically not distributed as widely as is 

economically feasible) in the interests of beneficial dynamic effects (getting those works created in the first 

place).

It is difficult to determine how close the current copyright regime is to being efficient—that is, whether the 

optimal balance between private incentives and social 

benefits has been reached. Given society’s desire for creative works, as well as its endowments of talent, technology, and other resources needed to generate and distribute those works, the question is whether current law and 

practice provide incentives for the greatest quantity and 

highest quality of original works to be created and consumed over time. Although the answer to that question is 

not straightforward, the magnitude of illicit consumption 

of copyrighted works in digital form today—music files 

shared over the Internet, for example, or movies and software illegally reproduced and distributed on CDROM—suggests that potential efficiency gains can be realized by applying advances in digital technology to legal 

markets for creative works. 

The Challenge to Copyright Law

The digitization of creative content poses a more serious 

challenge to copyright law than did earlier episodes of 

technological advance. A particularly significant aspect of 

that challenge is that digital technologies continue to increase the ways in which individuals can consume and enjoy creative works—for example, by “ripping” music files 

from a CD to store on a computer or portable music device—despite the fact that copyright law does not explicitly permit those uses without the authorization of the 

copyright owner. At the same time, advances in digital 

technologies provide copyright owners with growing capacity to either restrict or charge for subsequent uses of 

their creative works. 

Furthermore, copyrighted works in digital form can be 

flawlessly and inexpensively reproduced and instanta-
viii COPYRIGHT ISSUES IN DIGITAL MEDIA

neously distributed worldwide. Copyright holders consequently fear that unauthorized copying and redistribution of their works will cause their economic returns to 

decline.

At the same time, copyright law today applies to a growing number of products. Although the most prominent 

disputes over digital copyright concern music and movies, copyright law also applies directly to other products, 

such as computer software. Some manufacturers of software and other products have responded to technological 

advances by proposing new types of product licenses to 

protect and extend their commercial interests. Those new 

licensing practices could, however, potentially run 

counter to consumers’ interests.

Changes to copyright law, moreover, can have ramifications that extend beyond the concerns of producers and 

consumers of copyrighted material to the well-being of 

related sectors of the economy. The availability of creative content in digital form contributes to the growth of 

industries such as computer hardware and peripherals, as 

well as telecommunications goods and services. Measures 

to protect copyrighted works—for example, a government mandate that a particular access- or copy-control 

technology be used to prevent infringement of copyrighted materials in digital form—therefore require careful deliberation. When and how the digital copyright debate is resolved could influence the nature and pace of 

future technological progress—and hence the growth of 

the economy.

Economic Analysis and

the Copyright Debate

Because of the growing number and diversity of interests 

with a stake in the digital copyright debate, many observers believe that the Congress may need to legislate a balance in copyright law between private incentives and societal gains. Economic analysis can illuminate the 

Congress’s search for that balance, but it cannot provide 

unambiguous conclusions about the best weighting of the 

interests of copyright holders and consumers. The “best” 

policy implies a distribution of returns based as much on 

what is fair as on what is efficient. Economics does not 

provide answers to questions of fairness.

Although economic analysis may not be able to determine the best copyright regime in terms of fairness or 

other norms of society—it cannot, for example, identify 

which group(s) should gain and which should lose as a result of any revision in copyright law—it can provide insights into how private incentives and social benefits in 

markets for creative works might be structured. To make 

outcomes in markets for copyrighted goods as efficient as 

possible—that is, to enable society to obtain the most 

from the creative efforts of its members—economic reasoning can offer several general principles for legislative 

deliberations about revisions to copyright law in response 

to technological change:

B Property rights and other elements of a regulatory regime for creative works should be regarded as instruments for allocating creative resources. Hence, existing 

copyright law should not be viewed as an absolute, inviolable set of rights to which either creators or consumers are entitled.

B Revisions to copyright law should be made without regard to the vested interests of particular business and 

consumer groups. Instead, they should be assessed 

with regard to their consequences for efficiency in 

markets for creative works and other products.

B Property rights are not free. For a system of property 

rights to be accepted and upheld, the costs of establishing and enforcing that regime must not exceed the 

eventual benefits from it. 

The usefulness of those general principles is not diminished by several additional factors that may constrain the 

specific contributions that economic analysis eventually 

makes to the digital copyright debate. The economically 

efficient level of copyright protection is difficult to determine, for example, because copyright applies to diverse 

creative works that incorporate varying degrees of creative 

and artistic expression—from journalism to literature, 

music, and movies—and to works of a more technical nature, such as software. A single property rights regime, 

therefore, may not produce efficiency in markets for all of 

those products.

Furthermore, not all aspects of markets for creative works 

lend themselves to economic analysis. In particular, while 

economists may confidently expect that abolishing copyright protection altogether will reduce the level and quality of creative output, they cannot easily predict how a 

less dramatic change in compensating copyright owners 
SUMMARY ix

will affect the number or quality of creative works being 

produced.1

Because the advances in digital technology that currently 

challenge copyright law are part of a broader trend in the 

development of information technologies, moreover, actions motivated by other concerns may have an effect on 

the feasibility and desirability of revisions to copyright 

law. For example, regulation of the peer-to-peer networks 

that enable file-sharing among personal computer users—the primary source of copyright infringement worries today—may eventually be justified not to protect intellectual property but rather to address concerns about 

other activities carried out on those networks, such as the 

dissemination of computer viruses and software packages 

that surreptitiously monitor an individual’s computer 

use.

Legislative Options

Three primary options are among those available to the 

Congress in its deliberations on the current copyright debate: forbearance, compulsory licensing of digital content, and revision of copyright law in favor of either copyright holders or consumers of copyrighted material. 

Under the first option—forbearance—the Congress would 

do nothing and allow market forces to work. Although the 

digitization of creative content has been the source of 

considerable conflict between copyright owners and consumers, it may eventually allow for a market-based solution. Recent advances in digital rights management 

(DRM) technology2 and the development of business 

models that take advantage of those advances indicate the 

potential for a market-based solution. 

DRM technology has the potential to enable copyright 

owners to engage in differential pricing—that is, to 

charge a price for their creative work that varies on the 

basis of the particular use(s) made of that work. Consumers would pay according to the particular “rights” that 

they are able to exercise over a copyrighted work in digital form. For example, DRM technology would prevent 

consumers who pay for only a few rights (say, to listen to 

a music file from a compact disc or the Internet) from exercising the additional usage rights (both to listen to and 

to make copies of the file) that are available to consumers 

who pay more. DRM technology could likewise be used 

to control consumers’ ability to redistribute the copies 

that are made. 

While DRM technology can increase copyright holders’ 

ability to profit from their works, it can also expand consumers’ access to copyrighted material by lowering the 

minimum price that creators and distributors of copyrighted works must charge to recoup their investment. 

Under a differential pricing scheme, consumers who have 

a low valuation of a particular usage—in the preceding 

example, those who simply want to listen to a music 

file—pay a lower price. Without differential pricing, 

those consumers may be priced out of the market for that 

music service.

Because both copyright owners and consumers benefit 

overall, differential pricing could increase the efficiency 

of markets for creative works. From a distributional 

standpoint, however, not all consumers would be net 

beneficiaries—particularly those whose valuation of 

copyrighted materials had previously exceeded the price 

they were required to pay for them.

Markets for copyrighted material in digital form are only 

now beginning to emerge. The feasibility and desirability 

of either DRM technology or the differential pricing that 

it enables may change. For example, the DRM technologies used to implement differential pricing may turn out 

to be so vulnerable that they cannot prevent or adequately restrict copyright infringement. Alternatively, if 

competitive pressures on markets for copyrighted works 

in digital form are weak, differential pricing may be less 

effective.

A second option available to the Congress would be to use 

compulsory licensing to set a price for certain types of creative 

works. The revenues generated could then be distributed 

to copyright owners according to the relative use of their 

works. Setting a fixed price for some types of copyrighted 

material, however, may be less efficient than using a differential pricing scheme. Under a compulsory licensing 

arrangement, the price of using copyrighted material 

1. While knowledge about decisionmaking in the creative process is 

limited, decisionmaking in the marketing and distribution of creative works probably rests on more tangible, well-specified factors 

and, hence, will be more amenable to economic analysis.

2. Digital rights management technology enables owners of copyrighted material in digital form to restrict the uses that are made 

of it; copyright holders often use DRM to convey rights to a particular use, such as copying, in exchange for payment or another 

contractual obligation.
x COPYRIGHT ISSUES IN DIGITAL MEDIA

would be the same for all consumers and for all works 

covered by the license. A single, flat-rate fee is unlikely to 

be “just right” from the standpoint of economic efficiency. Administratively, the price-setting process could 

also be costly and protracted, leading to delays in the 

emergence of markets for the corresponding creative 

works.

From an equity point of view, levying a fee on computers 

and other equipment used to access certain creative works 

could also impose a tax on the use of that equipment for 

activities unrelated to the copyrighted materials in question. For example, taxing purchases of computers or 

other digital media to compensate recording artists for 

Internet downloads would force individuals who use 

computers for other purposes to subsidize the online music consumption of others. It is also unclear whether the 

usage of each copyrighted work could be tracked accurately enough for many copyright owners—particularly 

those offering relatively few creative works—to receive 

applicable royalty payments.

Because technological advances are expanding the options for consuming music, movies, and other copyrighted material, however, compulsory licensing could 

potentially reduce transaction costs in markets for creative content. The more comprehensive the range of uses 

of copyrighted material that consumers were offered under a compulsory license for a broad class of creative 

works, the less time they would have to spend reading exhaustive licensing agreements for different copyrighted 

products. In addition, the litigation costs incurred to obtain legal determinations of copyright infringement 

would be lower, as would the costs of enforcement.

A third option available to the Congress would be to revise 

copyright law in favor of one of the groups whose interests are 

at stake in the copyright debate: the copyright owners or the 

users of copyrighted material. Modifying copyright law to 

favor copyright owners could increase the feasibility of 

differential pricing and, hence, increase the efficiency in 

copyright markets. The advantages of differential pricing 

plans are not so clear, however, when those arrangements 

are facilitated either by the expansion of copyright owners’ rights at the expense of consumers’ ability to make 

“fair use” of copyrighted materials or by the imposition of 

a government-mandated technological measure to protect 

against copyright infringement.3 Restricting fair use in 

applications where the benefits to society presumably 

outweigh the revenues denied to the copyright owner—

for example, criticism, comment, news reporting, teaching, scholarship, or research—may not produce a great 

increase in efficiency because some socially beneficial uses 

of copyrighted material could become prohibitively expensive. Allowing copyright owners to have too much 

control could exacerbate the compromised efficiency that 

some differential pricing schemes can create in the presence of weak competitive pressures. The costs to society 

of greater enforcement of digital property rights, moreover, could potentially outweigh efficiency gains. Such a 

scenario could arise, for example, if digital copyright enforcement was so strict that it either prevented advances 

in digital hardware and communications or curtailed usage and development of the Internet.

Revising copyright law in favor of consumers, in contrast, 

could lead to inefficiency by making differential pricing 

less feasible. Potential costs to copyright owners from legislative revision of copyright law in favor of consumers 

could be mitigated by either cost savings or increased revenues from new business models made possible by advances in digital processing and distribution technologies. 

From an equity standpoint, revising copyright law in favor of consumers of creative material would represent a 

transfer of control from copyright owners to consumers. 

However, recent legislation that extended the duration of 

copyright protection may already have compensated 

some incumbent copyright holders, at least in part, for 

losses suffered from diminished control over their creative 

works.

When considering any legislative option for revising 

copyright law—whether one of those discussed in this paper or some other option—it is important to be mindful 

of the possibility that a modification to copyright law 

could have unintended consequences. Any revisions that 

are undertaken, therefore, require careful deliberation.

3. “Fair use” is any use of copyrighted material that does not infringe 

copyright even though it is done without the authorization of the 

copyright holder and without an explicit exemption from 

infringement under copyright law.
1

The Current Copyright Debate

Copyright grants to creators exclusive rights over 

their original works. After a copyright expires, the creative work enters the public domain and may be used 

freely. Copyright law is thus characterized by the balance 

it seeks to achieve between private incentives to engage in 

creative activity and the social benefits deriving from the 

widespread use of creative works. 

In recent years, that balance has been severely challenged. 

The digitization of creative content and the rapid pace of 

technological advances that enable the ready distribution 

and widespread use of that content are exerting pressure 

on U.S. copyright law. To support Congressional consideration of potential changes to copyright law, this paper 

examines the following:

B the distinguishing features of the current copyright debate;

B the economic significance of industries that are likely 

to be affected, both directly and indirectly, by changes 

to copyright law;

B the main features of copyright law;

B the continuing evolution of copyright law in response 

to the increasing availability of creative content in digital form; 

B the economic motivation for copyright law and how it 

contributes to efficiency in markets for creative works; 

and

B the implications of proposed legislative remedies for 

economic efficiency and equity. 

Technological progress is placing new strains on copyright law today. Indeed, revising current copyright law is 

more difficult now than in the past for four key reasons. 

First, the rapid advance of digital technology is creating 

new conflicts between copyright owners and consumers 

over the control of legally acquired creative works in digital form. Second, technological progress is posing unprecedented obstacles to copyright enforcement both domestically and internationally. Third, technological advances 

affect a much wider variety of creative works than in years 

past, when copyright disputes were more focused. 

Fourth, advances in digital technology affect many sectors of the economy beyond those directly concerned 

with copyright; consequently, revisions in copyright law 

that have an impact on the development or application of 

that technology are likely to influence innovation and the 

economy overall.

Disputed Control 

of Copyrighted Works

Technological progress has exacerbated conflicts over 

control of copyrighted works. The allocation of rights between copyright owners and consumers over subsequent 

uses of creative works, always a relatively indeterminate 

area of copyright law, has become even more unsettled as 

a result of digital technology. Advances in digital technology have increased the potential gains that either copyright owners or consumers might realize from exercising 

control over subsequent uses of legally acquired copyrighted works in digital form. As a result, the allocation 

of those gains is highly contested.

The options available for consuming creative works today 

are considerable. Digital media products such as MP3 

players give individuals new alternatives for making, storing, and listening to copies of music that they have purCHAPTER
2 COPYRIGHT ISSUES IN DIGITAL MEDIA

chased. TiVo and related digital recording devices allow 

individuals to personalize their television viewing, 

thereby freeing them from network scheduling of television broadcasts as well as advertisements. Finally, products that allow consumers to remove objectionable material during the replay of a movie are becoming widely 

available.1

While the digitization of creative works has expanded the 

options for consuming copyrighted material, copyright 

owners have begun to exploit similar technological developments to control those options. As a result, activities to 

which consumers of creative works have become accustomed—for example, making copies of digital music files 

or television broadcasts for personal use—may in the future require the copyright owner’s approval and, in particular, payment of an additional fee to obtain that authorization. Any attempt to resolve digital copyright 

conflicts may be caught between copyright owners’ desire 

to maintain control over their intellectual property and 

the ethics and expectations of consumers who have become accustomed to making relatively unfettered use of 

creative works in digital form.

New Obstacles to Copyright

Enforcement

Copyright owners confront two primary obstacles to enforcement that appear potentially more important today 

than during earlier copyright disputes. Increasingly, 

copyright infringement is an issue both at the individual 

level and in the international arena.

Infringement by Individuals

The digitization of creative content is lowering the cost of 

copyright infringement by individual consumers. Greater 

computer processing power and storage capacity, as well 

as the proliferation of file-sharing on peer-to-peer networks, have facilitated the unauthorized use of creative 

works. As a consequence, private individuals, rather than 

commercial entities, are increasingly the targets of copyright-enforcement efforts.2

Infringement at the International Level

The ease of replication and redistribution of creative 

works in digital form facilitates the instantaneous, global 

availability of copyright-infringing works. Consequently, 

the effectiveness of any nation’s efforts to protect the 

rights of its copyright owners depends increasingly on international coordination of enforcement efforts and the 

harmonization of copyright law across countries.

International copyright issues are particularly urgent for 

the United States, whose copyright owners earn considerable revenues from licensed distribution of their works 

abroad. The U.S. movie industry, for example, earns 

roughly the same amount of box office receipts abroad as 

it does domestically. The major sources of revenue for the 

movie industry today, however, are movie sales and rentals in digital videodisc (DVD) format.3

 Because movie 

DVDs are particularly vulnerable to copyright infringement by illicit manufacturing operations abroad, the U.S. 

motion picture industry increasingly views international 

harmonization and enforcement of copyright law as a key 

factor in its future revenue growth. The sound recording 

and software industries, whose music and software com1. See “Coming Soon: The Smut-Free DVD,” BBC News, April 8, 

2004, available at http://news.bbc.co.uk/1/hi/business/

3611969.stm; and Katie Dean, “Much Ado About Smut-Free 

DVDs,” Wired News, June 3, 2003 (available at http://

www.wired.com/news/digiwood/0,1412,59071,00.html). The 

proposed Family Movie Act of 2004 (H.R. 4586) would provide 

an explicit exemption from copyright infringement for consumer 

editing of copyrighted movies to remove material deemed objectionable.

2. One implication of that development is that individual privacy 

may one day become less a right than a commodity, as consumers 

grant permission for the monitoring of their use of copyrighted 

materials in exchange for legal access to copyrighted materials or 

even for reduced prices for that access. Eventually, advances in 

information technology may call into question the nature of both 

the personal and property rights regimes that are currently in force 

in the economy. See J. Bradford DeLong and A. Michael 

Froomkin, “Speculative Microeconomics for Tomorrow’s Economy,” in Brian Kahin and Hal Varian, eds., Internet Publishing 

and Beyond: The Economics of Digital Information and Intellectual 

Property (Cambridge, Mass.: MIT Press, 2000), pp. 6-44.

3. According to the Motion Picture Association, box office receipts 

earned internationally were $37.9 billion for the 2000-2003 

period, while domestic box office earnings totaled $35.1 billion 

(see MPA Worldwide Market Research, available via e-mail upon 

request at http://www.mpaa.org/useconomicreview). During 

roughly the same time, consumer adoption of the DVD format 

grew rapidly. Revenues from the sale and rental of movies on 

DVD now account for over half of total movie industry revenues; 

some films that were unsuccessful at the box office have generated 

revenues in the film-rental and -purchase markets. See Sharon 

Waxman, “Studios Rush to Cash In on DVD Boom,” New York 

Times, April 20, 2004; and Kate Bulkley, “DVD Sets Rules for 

Hollywood,” Financial Times, January 22, 2004. 
CHAPTER ONE THE CURRENT COPYRIGHT DEBATE 3

pact discs are similarly vulnerable to copyright infringement abroad, share the concerns and views of the U.S. 

movie industry.

Potential Impact of Copyright Law 

Revisions on Innovation and 

Economic Growth

More than in the past, revisions to copyright law today 

may quickly become enmeshed with developments in industries not directly concerned with copyright. Technological progress continues at a rapid pace in the hardware 

and telecommunications products that enable the processing and distribution of creative content in digital 

form. As a result, those industries are making important 

contributions to productivity in the overall economy. 

Any government-imposed mandate that a particular technology—an encryption or copy-control program, for example—be used to thwart copyright infringement should 

weigh the implications of that mandate for future innovation.

The popular new wireless technology known as Wi-Fi 

provides a good illustration of the vigor of technological 

advance. The continuing expansion of Wi-Fi networks 

may enable inexpensive high-speed Internet access for 

many users of mobile computing devices. The emergence 

of those networks, however, has been facilitated by technological and commercial experimentation. Both technology standards and the business models through which 

Internet access is available over Wi-Fi networks continue 

to evolve. Depending on a mobile user’s location, Wi-Fi 

access may be available free of charge, often paid for by a 

commercial establishment that the user frequents, or it 

may be available only to subscribers. 

The technological and commercial development of Wi-Fi 

networks would have been significantly more difficult 

under a property rights regime that required those networks to authenticate the identity of all users able to access the Internet through that network—a requirement 

that could enable the tracking of copyright infringers, for 

example. That is not to argue that technological regulation is always ill-advised or that operators of Wi-Fi networks should not be held accountable for what transpires 

on them. Rather, it is important to recognize that the development of a new technology is often a precarious process that premature regulation can potentially threaten.

Copyright law affects different sectors of the economy to 

varying degrees. At first approximation, “core” copyright 

industries can be distinguished from “copyright-related” 

industries.4 Comparisons of the economic and social importance of industries with a stake in the outcome of current copyright conflicts are not straightforward. 

The computer hardware and telecommunications industries, for example, provide goods and services that do not, 

as a rule, benefit directly from copyright protection. Yet 

those copyright-related industries, which could be affected by a technology mandate aiming to protect copyrighted works in digital form, have greater economic 

weight (in terms of gross revenues) than do the core music and movie industries currently at the heart of the debate over digital copyright law. Innovation in computer 

hardware and telecommunications has played a key role 

in the economy’s recent growth and, according to all indications, will continue to do so in the future. Hence, deliberations about modifying digital copyright law to address the concerns of a particular industry must consider 

the consequences for economically important, related industries. At the same time, it is important to keep in 

mind the fact that innovation in those copyright-related 

industries also benefits, through patent protection, from 

laws that protect intellectual property. 

Core Copyright Industries

Core copyright industries are those whose revenues depend directly on the production or dissemination of 

copyrighted works. They have traditionally been in the 

news and entertainment sector—journalism; literature; 

sound recordings and movies; and radio, television, and 

4. The categorization of “core” and “copyright-related” industries 

comes from Stephen Siwek, Copyright Industries in the U.S. Economy: The 2002 Report, produced for the International Intellectual 

Property Alliance (IIPA) and available at http://www.iipa.com/

copyright_us_economy.html. That report includes in the core 

copyright sector two industries that this paper excludes from that 

category: advertising; and information and data processing services. This paper excludes those industries because it is unclear 

how many of those activities involve copyrighted, rather than 

trademarked or simply proprietary, materials. On the other hand, 

this paper recognizes providers of telecommunications goods and 

services as copyright-related industries because they increasingly 

enable both the distribution and use of copyrighted material in 

digital form.
4 COPYRIGHT ISSUES IN DIGITAL MEDIA

Figure 1-1.

Distribution of Gross Revenues Across Core Copyright Industries, 2002

(Billions of dollars)

Source: U.S. Census Bureau, 2002 Service Annual Survey.

Note: Two data limitations deserve mention. First, the data do not reflect the value to society of copyrighted works that are pirated, that is, 

copied and distributed without a license. Second, the data reflect some double-counting in that receipts from licensed broadcasts of 

music and movies are included in the revenues of those producing industries as well as the radio, television, and cable broadcasting 

industries. Employer firms reported that in 2002, for example, broadcast rights and music license fees in the radio and television 

broadcasting industry were $12.8 billion, while program and production costs (which include more than license fees) for the cable 

broadcasting industry were $24.4 billion.

cable broadcasting. More recently, computer software has 

become an important core copyright industry.

The gross revenues of the core copyright industries totaled $441.4 billion in 2002 and were distributed as 

shown in Figure 1-1. Nearly a third of that total ($143.4 

billion) came from the newspaper, periodical, and book 

publishing industries. The music industry, which generated $13.9 billion in gross revenues in 2002, is the smallest segment. (See Box 1-1 for details on the interpretation 

of data on gross revenues.)

In deliberations over copyright law, it is important to 

keep in mind the diversity of industries that are directly 

affected. For example, the production and distribution of 

works of journalism traditionally differ from those used 

for music or movies. News organizations typically produce and distribute content on a more frequent or regular 

basis than do music and motion picture enterprises. Because journalism and news operations provide value in 

part through the timeliness of their efforts, they may have 

more options for appropriating revenues from their copyrighted works (for example, newspaper subscriptions and 

advertising) than do other core copyright industries. As a 

consequence, the importance of the rigorous application 

of digital copyright law may differ by industry.

Copyright-Related Industries

Copyright-related industries produce goods used in conjunction with copyrighted materials. Examples include 

the computer hardware and consumer electronics industries and, increasingly, telecommunications and the Internet.5

Publication of Newspapers

Periodicals,

Books, etc.

 (143.4)

Software

Publishing

 (89.4)

Cable

Broadcasting

 (80.7)

Motion Picture

and Video

 (61.7)

Radio and Television

Broadcasting

 (52.3)

Sound Recording

and Music Publishing

 (13.9)

5. Post-2001 data for those and other copyright-related industries 

are not available in sufficient detail for purposes of this analysis. 

The figures do not reflect all of the retail and wholesale trade that 

takes place over the Internet and therefore could be affected by 

digital copyright legislation that targets Internet activity. Nor do 

the figures take into account the many other products, such as 

automotive components, that incorporate computer chips supported by software and are thus potentially subject to copyright 

law.
CHAPTER ONE THE CURRENT COPYRIGHT DEBATE 5

S

Computer Hardware and Consumer Electronics. According to the U.S. Census Bureau’s 2001 Annual Survey of 

Manufactures, $78.7 billion of computers and peripheral 

hardware were manufactured in the United States in 

2001, along with $8.3 billion of radio, television, and

stereo equipment. Those industries have considerable 

weight in the economy relative to many of the core copyright industries, and their past performance and future 

prospects indicate rapid rates of technological advance. 

As a result of sustained progress in manufacturing techniques, which manifests itself in continuing quality improvement coupled with stable or even declining unit 

sales prices, real final sales of computer and peripheral 

hardware displayed double-digit growth rates each year 

from 1990 to 2003, rising at a compound annual rate of 

32.6 percent.6 Technological advances in semiconductor 

and computer manufacturing are widely expected to continue well into the future. Because the use of those products is so pervasive, technological progress in those industries constitutes one of the few reliable contributors to the 

future growth of productivity and output in the overall 

economy. Realizing the full potential of that progress, 

however, may well depend upon finding a resolution to 

current digital copyright disputes.

Take the changing nature of computer demand, for example. Consumer purchases are increasingly moving 

away from the personal computer (PC) platform to media devices that incorporate hardware and software elements traditionally found in computers. Digital video recorders (DVRs), which permit the recording and replay 

of television programs, may come with hard drives of 160 

gigabytes, while the typical home PC has a 40-gigabyte 

hard drive. Some hard disk manufacturers report that deBox 1-1.

Interpreting Gross Revenue Data

Industry comparisons based on gross revenues are 

subject to three important qualifications. First, gross 

revenues do not reflect net output (or value creation), so in principle an industry could report 

higher-than-average gross revenues simply because it 

made intensive use of costly inputs. However, the 

U.S. Census Bureau collects input costs for the service sector, where the core copyright industries are 

classified, only every five years, and the most recent 

data available are for 1997.1

 Gross revenues, in contrast, are available as recently as 2002. 

Second, the amount that a particular industry earns 

in revenues, either gross or net, does not necessarily 

indicate its importance to society. For example, the 

relatively low selling price of a plentiful commodity 

may belie its much larger contribution to society’s 

well-being. Indeed, creative works such as literature, 

music, and film might eventually have a larger impact on society than the revenues earned from their 

production and distribution would suggest.

Finally, industry-specific revenue data do not take 

into account sectoral interdependencies. Innovations 

in digital processing and distribution technologies, 

such as the digital videodisc format, can enhance the 

production and distribution potential of core copyright industries such as motion pictures. Conversely, 

the widespread availability of creative content in digital form can increase the demand for goods and services from the copyright-related computing and telecommunications sectors.

Despite those qualifications, however, revenue measures do allow for some inferences about the various 

economic interests of participants in the copyright 

debate. 

1. Results from the 2002 Economic Census for the core copyright industries are scheduled for release in the fall of 2004. 

See http://www.census.gov/econ/census02/guide/

index.html. 

6. Final sales of computers consist of total domestic production 

minus net imports. See Bureau of Economic Analysis, “Final Sales 

of Computers,” June 25, 2004, available at http://www.bea.doc.

gov/bea/dn/comp-gdp.xls; for a review of literature on productivity and output growth in the United States, see Congressional 

Budget Office, The Role of Computer Technology in the Growth of 

Productivity (May 2002).
6 COPYRIGHT ISSUES IN DIGITAL MEDIA

mand from consumer electronics is growing roughly 

seven times faster than demand from traditional computer-related markets and could eventually account for 

half of their business. As demand for consumer electronics grows, the requirements of processing and displaying 

video in digital format are claiming processor and terminal production that would otherwise have been allocated 

to PCs. Purchasers of consumer electronics and PCs, 

meanwhile, are enjoying the same technological advances.7

Some observers suggest that, partly as a result of the convergence of personal computing and consumer electronics, consumer purchases may claim a greater share of total 

demand for computing products than business investment, which has in the past been by far the largest source 

of demand for computer hardware and peripherals.8

However, owners and distributors of creative works such 

as literature, music, and movies are unwilling to make 

copyrighted material widely available in digital format 

unless they are sure that they can adequately protect that 

material from piracy. 

The outcome of the current copyright debate is one of 

many factors, including the level of research and development, important to the future growth of information 

technology industries. Consequently, continued growth 

in consumer purchases of digital processing equipment—

and, by extension, the continued enjoyment of technological progress and productivity gains from the manufacture of that equipment—is linked to the satisfactory resolution of digital copyright disputes. 

Telecommunications. Goods and services from the telecommunications industry are frequently used in conjunction with copyrighted materials. Networks that transmit 

voice calls also carry Internet traffic, which increasingly 

includes copyrighted material in both licensed and pirated form. Equipment for digital networking in the 

home, which enables computing and digital entertainment devices to exchange data, is enjoying fast-growing 

popularity among consumers. Wi-Fi, the underlying 

technology, is considered a relatively inexpensive way of 

providing wireless, broadband Internet access. As part of 

the convergence of computing and consumer electronics, 

other telecommunications products, such as wireless 

phones, are acquiring the capacity of traditional computing devices to receive and process voice, video, and audio 

content.9

Business investment in telecommunications equipment 

totaled $90.6 billion in 2001, which is roughly equal to 

the value of domestic sales of telecommunications equipment that year. (Many consumer telecommunications 

products, such as cell phones, are imported.) Like innovation in computer and peripheral hardware, innovation in 

telecommunications equipment is robust, although not 

always captured by official economic statistics.10

The rapid growth in telecommunications investment in 

the late 1990s, which contributed significantly to overall 

economic growth during that period, was spurred by the 

economic potential seen in the Internet. Accordingly, 

continued investment in the telecommunications sector 

depends in part on the demand for high-speed Internet 

service, which in turn depends upon the availability of 

high-quality content that can be accessed via those networks. Again, copyright owners claim that they are reluctant to make their creative works available until their 

concerns about copyright infringement are satisfied.

Gross revenues of telecommunications services totaled 

$367.2 billion in 2001. Over $78 billion of those revenues came from cellular and other wireless communications services, the value of which more than doubled, in 

nominal terms, after 1998 and accounted for over half of 

the increase in the value of telecommunications services 

between 1998 and 2001.

Continuing growth in cellular communications services 

hinges on the availability of additional wireless frequency 

bands, which in turn depends upon the willingness of 

television broadcasters to shift from the frequency bands 

in which they currently transmit to smaller frequency 

bands suitable for digital broadcasts. The speed of that 

transition, television broadcasters say, is contingent on 

the availability in digital form of copyrighted creative 

7. See John Markoff, “New Intel Chip for Digital TV Could 

Remake the Market,” New York Times, December 17, 2003.

8. See Simon London and others, “The Two-Speed Tech Sector,” 

Financial Times, December 1, 2003.

9. See Matthew Maier, “Mobile Entertainment Goes Hollywood,” 

Business2.com, December 11, 2003; and Alex Salkever, “The 

Many Shapes of Tomorrow’s PC,” Business Week, November 4, 

2003.

10. See Congressional Budget Office, The Need for Better Price Indices 

for Communications Investment (June 2001).
CHAPTER ONE THE CURRENT COPYRIGHT DEBATE 7

content, such as movies and sports programs, which 

copyright owners are reluctant to provide without satisfactory safeguards against infringement.

What constitutes copyright infringement and the challenges to copyright law from advances in digital technology are examined in the next chapter. 

2

Copyright Law and Technological Change

Copyright law’s effort to balance private incentives 

to produce and distribute creative works with the benefits 

to society that arise from widespread access to those 

works is evident in the constitutional language that authorizes the Congress to establish copyrights and patents. 

Article 1, section 8, of the U.S. Constitution grants the 

Congress the “Power . . . to Promote the progress of Science and useful Arts, by securing for limited Times to 

Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” The rights that copyright 

owners can claim over creative works are not always welldefined, however, and some areas of copyright law remain 

unsettled.

The Rights of Copyright Holders

The U.S. Copyright Act states that a copyright exists 

once an “original work of authorship [is] fixed in any tangible medium of expression . . . from which [it] can be 

perceived, reproduced or otherwise communicated.”1

However, a copyright applies only to the expression of an 

idea in a creative work and not to the idea itself (see Box 

2-1).2

Reflecting the property rights regime embodied in copyright law, the U.S. Supreme Court, in Dowling v. United 

States, recognized a distinction between copyright infringement and theft.3

 The Court pointed out that “the 

copyright owner . . . holds no ordinary chattel. A copyright, like other intellectual property, comprises a series of 

carefully defined and carefully delimited interests to 

which the law affords correspondingly exact protections” 

by specifying the penalties for infringement. In that particular case, although the infringing parties caused pecuniary damage to the copyright owner, they were not 

guilty of theft by their unauthorized pressing and sale of 

vinyl albums of Elvis Presley’s recordings because they did 

not “assume physical control over the copyright nor 

wholly deprive its owner of its use.”

Private incentives to create are supported by the exclusive 

rights that owners of copyright enjoy. Copyright owners 

(or their assignees) have the right to carry out or authorize reproduction and distribution of their work; preparation of derivative works; and, for literary, musical, and 

various visually based works, the public performance or 

display of their work.4

 Among other advantages for creators—for example, ensuring attribution for, and the integrity of, their original work in authorized uses—those 

exclusive rights enable copyright owners to realize economic returns from their creative efforts.

Limitations on the Rights

of Copyright Holders

In keeping with the constitutional goal of promoting science and the arts, however, several constraints are placed 

on the rights of copyright owners. First, copyright is 

granted for only a limited time. On works of individual 

authorship, copyright extends for the life of the author 

plus 70 years. On works for hire, copyright runs for 95 

CHAPTER

1. 17 U.S.C. 102(a). The U.S. copyright statute and related laws are 

contained in Title 17 of the United States Code.

2. Copyright protection is similarly denied to any “procedure, process, system, method of operation, concept, principle, or discovery, regardless of the form in which it is described, explained, 

illustrated, or embodied in such work.” 17 U.S.C. 102(b).

3. 473 U.S. 207 (1985).

4. For sound recordings, public performance includes digital audio 

transmissions. The scope and limitations of the exclusive rights of 

copyright holders are specified in greater detail in 17 U.S.C. 106 

and 17 U.S.C. 107-122.
10 COPYRIGHT ISSUES IN DIGITAL MEDIA

years from first publication or 120 years from creation, 

whichever expires first.5

 After copyright protection has 

ended, the work enters the public domain and may be 

used without authorization of the copyright owner.

Copyright law also imposes limitations on the exclusive 

rights that copyright owners enjoy during the life of a 

copyright. Some of those limitations apply to the use of a 

particular product, such as consumers’ ability to make an 

archival copy of a computer program without authorization of the copyright owner.6 Others are much broader in 

scope and apply to copyrighted works generally. The two 

most prominent examples of comprehensive limitations 

on the exclusive rights of copyright owners are the “first 

sale” doctrine and exemptions from copyright infringement as determined by “fair use” criteria.

The first sale doctrine stipulates that the owner of a legally obtained copy of a copyrighted work may “sell or 

otherwise dispose of the possession of that copy” without 

the authorization of the copyright owner. Thus, this doctrine concerns rights to distribute—not to reproduce—

copyrighted material.7

Certain unauthorized uses of copyrighted material may 

also be exempt from copyright infringement if they satisfy fair use criteria. As examples of the types of uses of 

copyrighted material that typically qualify as fair use, 

copyright law lists “criticism, comment, news reporting, 

teaching (including multiple copies for classroom use),

Box 2-1.

Protection Afforded to Collections of Facts

The courts have held that the terms under which the 

Constitution grants the power of copyright to the 

Congress prevent facts or collections of facts from receiving copyright protection. One exception to this 

ruling is a collection of facts that embodies a sufficient component of originality and creativity in the 

selection, coordination, or arrangement of those 

facts. Even then, only those original and creative 

components—not the facts to which they are attached—can be copyrighted. One such case—Feist 

Publications v. Rural Telephone Service, Inc.—concerned whether phone books could be copyrighted.1

Databases that do not contain an original or creative 

component, therefore, do not qualify for any protection under copyright law. Currently such databases 

are protected by state-level prohibitions against misappropriation and unfair business practices.2

 Database suppliers argue that the investment needed to 

generate databases may be compromised in the digital era by unauthorized copying and redistribution. 

They assert that stronger protection is needed to preempt state laws and thereby ensure uniformity of application. As an alternative to copyright protection, 

the Database and Collections of Information Misappropriation Act (H.R. 3261) was introduced in the 

108th Congress. H.R. 3261 establishes the conditions necessary for invoking misappropriation under 

the Commerce Clause to enforce property rights 

over certain types of databases and collections of information.

1. 499 U.S. 340 (1991).

2. However, some observers have voiced concern that the 

inclusion of a minimal amount of copyrighted material may 

enable database suppliers to claim copyright protection 

under 17 U.S.C. 1201(a)(1). See discussion preceding Final 

Rule on “Exemption to Prohibition on Circumvention of 

Copyright Protection Systems for Access Control Technologies,” 65 Fed. Reg. 64556, 64566 (2000).

5. 17 U.S.C. 302(a) and (b).

6. 17 U.S.C. 117. 

7. 17 U.S.C. 109(a). The first sale doctrine does not apply to the 

“rental, lease or lending” of a sound recording or computer program for commercial advantage; see 17 U.S.C. 109 (b)(1)(A).
CHAPTER TWO COPYRIGHT LAW AND TECHNOLOGICAL CHANGE 11

scholarship, or research.” Determination of fair use is a legal judgment made on a case-by-case basis.8

Unsettled Areas of Copyright Law

Fair use is a relatively indeterminate area of copyright law 

that can quickly become contentious when a new technology changes how creative works are produced and 

used. Consumers of copyrighted works, for example, may 

believe that they can legally make a copy of creative material for personal use without authorization from the copyright owner. However, such activity has not been recognized as fair use. Consumers’ belief to the contrary may 

reflect, in part, a lack of legal precedent. 

For the legality of any type of personal copying to be established—that is, for either the Congress to modify 

copyright law or the courts to be called upon to make a 

fair use determination—copyright owners or consumers 

must have sufficient incentive to force the issue legislatively or judicially. Forcing the issue presupposes that 

copyright owners in particular not only feel sufficient 

economic injury from the unauthorized copying but also 

believe that an eventual prohibition against it can be implemented successfully. Both those conditions have not 

always been present.

Consequently, the legality of making personal copies under the fair use provision of copyright law may be unclear 

or misunderstood by creators and consumers of copyrighted material. Digital technologies available today allow consumers to enjoy copyrighted works in a variety of 

new ways and, at the same time, enable copyright owners 

to exercise greater control over subsequent uses of their 

works. As a result of technological progress, the unsettled 

area of fair use has become quite contentious. 

The 1984 case of Sony v. Universal Studios is a prominent 

example of how a new technology for consuming creative 

works prompted a legal clarification of fair use.9 Universal Studios argued that individuals’ use of videocassette 

recorders (VCRs) to make copies of television broadcasts 

would lead to a loss of advertising and other revenues 

and, furthermore, that the production or import of VCRs 

should be banned on the grounds that they contributed 

to copyright infringement.

The U.S. Supreme Court held that making television 

broadcasts for later viewing—a practice known as “timeshifting”—constituted fair use. Surveys of VCR owners 

also found that videocassette recorders were primarily 

used for that purpose and that TV viewing overall—and 

hence the economic health of the broadcasting industry—had not declined. On that basis, the Court held that 

the sale of VCRs did not constitute contributory infringement of copyright despite the potential use of that 

equipment for infringing uses, such as making and selling 

multiple unauthorized videocassette copies to the economic detriment of the copyright owner.

Advances in information technology—particularly the 

digitization of a growing volume of creative works and 

the increasingly rapid processing and distribution of 

digital content—are forcing a reassessment of how well 

copyright law defines the rights of copyright owners 

while recognizing the interests of consumers. Judicial and 

legislative efforts to address copyright issues arising from 

digital technology are examined below. 

Copyright Law Modifications 

for Digital Media

Legislative and judicial attempts to retool copyright law 

for digital media (see Box 2-2) have attempted to balance 

the rights of copyright owners (and hence private incentives to engage in creative activity) with the interests of 

consumers (and the benefits to society). With the advent 

of the Internet, however, copyright disputes have intensified. Copyright owners, concerned about losing control 

over their works in digital form, fear that their economic 

returns will be reduced. At the same time, users of copyrighted material argue that copyright owners may exploit 

digitization to expand control over those works, thereby 

restricting consumers’ ability to enjoy them without obtaining prior consent from the copyright owner. As a result, several features of copyright law—in particular, fair 

use—are increasingly being contested.

8. 17 U.S.C. 107. Criteria that the courts must apply to determine 

fair use are the nature of the use being made of the copyrighted 

work (that is, whether for commercial or nonprofit purposes); the 

potential economic effects of that use on the value of the copyrighted work; the type of copyrighted work in question (original 

works are less subject to fair use exemptions than factual or 

descriptive works); and the amount of the creative work being 

used.

9. 464 U.S. 417 (1984).
12 COPYRIGHT ISSUES IN DIGITAL MEDIA

Early Legislation

The earliest copyright legislation concerning digital content applied to software and represented an effort to balance the interests of copyright owners and consumers. In 

1980, the Congress amended the copyright law to allow, 

for archival purposes, copies of computer software programs to be made without infringing copyright.10 In the 

Computer Software Rental Amendments Act of 1990, 

the Congress revised copyright law to protect the interests 

of copyright owners by prohibiting software purchasers 

from renting their copies of that software.11

The first major legislative act devoted exclusively to digital copyright law was the Audio Home Recording Act 

(AHRA) of 1992.12 An attempt to balance the rights of 

copyright owners and consumers is evident in that law. 

Prompted by the emergence of digital equipment capable 

Box 2-2.

Recent Legislative and Judicial Responses to Copyright Issues Arising from the Digitization of Creative Works

Legislative Revisions

B Computer Software Rental Amendments Act of 

1990 (Pub. L. No. 101-650). Prohibits the leasing of software products.

B Audio Home Recording Act of 1992 (Pub. L. No. 

102-563). Exempts from copyright infringement 

the making of copies for personal use of music 

files in digital form, provided that those copies 

are made with approved equipment.

B No Electronic Theft Act of 1997 (Pub. L. No. 

105-147). Establishes penalties for unauthorized 

sharing and redistribution of copyrighted material over the Internet.

B Digital Millennium Copyright Act of 1998 (Pub. 

L. No. 105-304). Creates several protection and 

enforcement mechanisms for copyrighted works 

in digital form.

B Technology, Education, and Copyright Harmonization Act of 2002 (Pub. L. No. 107-276). Provides an exemption from infringement for some 

uses of digital copyrighted materials used in distance learning.

B Small Webcaster Settlement Act of 2002 (Pub. L. 

No. 107-321). Establishes guidelines and requirements for the payment, collection, and distribution of fees paid by small commercial entities for 

the use of copyrighted works in certain Internet 

transmissions. 

Judicial Interpretations

B Recording Industry Ass’n of America, Inc. v. Diamond Multimedia Systems, Inc., 180 F.3d 1072 

(9th Cir. 1999). Found that MP3 players are not 

in violation of the Audio Home Recording Act.

B Metro-Goldwyn-Mayer Studios, Inc. v. Grokster, 

Ltd., 259 F. Supp. 2d 1029 (C.D. Cal. 2003). 

Determined that the Grokster file-sharing service 

has substantial noninfringing uses and, hence, is 

not liable for contributory infringement.

B Recording Industry Ass’n of America, Inc. v. Verizon 

Internet Services, Inc., 351 F.3d 1229 (D.C. Cir. 

2003). Ruled against the RIAA in its use of the 

Digital Millennium Copyright Act’s subpoena 

provision to obtain identifying information about 

individual Internet users suspected of infringing 

copyright.

10. 17 U.S.C. 117(a).

11. 17 U.S.C. 109(b)(1)(A).

12. Pub. L. No. 102-563, 106 Stat. 4237 (codified in scattered sections of 17 U.S.C.).
CHAPTER TWO COPYRIGHT LAW AND TECHNOLOGICAL CHANGE 13

of making flawless reproductions of musical recordings, 

the AHRA prohibited the manufacture or import of “digital audio recording devices” unless such equipment incorporated a mandated technology (or its equivalent) to 

prevent serial copying. It also imposed a levy on the sale 

of that equipment and on the digital recording media, 

such as digital audiotapes, associated with it, with receipts 

from that levy going to copyright owners. In exchange, 

the AHRA explicitly granted consumers an exemption 

from copyright infringement for their use of either an approved digital audio recording device or analog equipment to make personal copies of musical recordings.

Subsequent digital copyright legislation has focused on 

emerging Internet-based activities. For example, the No 

Electronic Theft (NET) Act of 1997 established penalties 

for certain types of sharing or distribution of copyrighted 

materials over the Internet regardless of whether that exchange is commercial or personal in nature.13 Unlike the 

NET Act, which emphasized enforcement, the Technology, Education, and Copyright Harmonization 

(TEACH) Act of 2002 expanded the provisions for exemptions from copyright infringement. In particular, 

TEACH specified the conditions for extending an earlier 

exemption that applied to certain performances and displays for educational purposes to the use of copyrighted 

materials in distance learning.14

The Digital Millennium Copyright Act 

The digital copyright legislation featured most prominently in current disputes is the Digital Millennium 

Copyright Act (DMCA) of 1998.15 The DMCA modified the details of copyright law in a variety of ways, including instituting a royalty-setting process for Internet 

music broadcasts (Webcasts) and specifying exemptions 

for library and archival copying. It also established two 

major provisions of current digital copyright law—the 

anticircumvention prohibitions and the safe-harbor requirements for Internet Service Providers (ISPs)—that 

are intended to enhance the ability of copyright owners 

to protect their work from infringing uses and to identify 

and prosecute those users found to be infringing copyright.

Anticircumvention Clause and Antitrafficking Provisions. 

The DMCA makes it illegal to circumvent a technology 

that controls access to copyrighted materials—for example, an encryption program that prevents unauthorized 

viewing of a movie on the Internet.16 Like the purchaser 

of a movie ticket, an Internet consumer would have to 

obtain the copyright owner’s authorization to view the 

movie by paying for the decryption key needed to view 

the digitized video file. The DMCA further prohibits 

manufacturing or trafficking in products “primarily designed or produced for the purpose of circumventing” 

technologies that are designed either to control access to 

copyrighted material (as in the previous example of a 

movie distributed via the Internet) or to prevent the use 

of such material in an infringing way.17

In contrast, the DMCA does permit some circumvention 

activities or products that do not infringe copyright. For 

example, copyright law explicitly recognizes copying a 

computer program for archival purposes as a limitation 

on the exclusive rights of owners of copyright on computer programs. Hence, if a manufacturer of computer 

programs applied a copy-control technology to prevent 

unauthorized copying of its product, a lawful purchaser 

could legally circumvent that technology to make an archival copy.

The example of software copying illustrates a central 

principle of copyright law: copyright owners have no legal obligation to facilitate any activity that qualifies either 

as a limitation on their exclusive rights or as fair use generally. At the same time, if the DMCA’s prohibitions are 

to be effective legal instruments for deterring infringement, copyright owners must take measures to protect 

their intellectual property from unauthorized access and 

use. 

13. 17 U.S.C. 506. Specifically, the NET Act made subject to criminal prosecution the willful infringement of copyright that is pursued either (i) for “purposes of commercial advantage or private 

financial gain, or (ii) through the reproduction or distribution, 

including by electronic means, during any 180-day period, of 1 or 

more copies or phonorecords of 1or more copyrighted works, 

which have a total retail value of more that $1,000.”

14. 17 U.S.C. 110.

15. Pub. L. No. 105-304, 112 Stat. 2869 (codified in scattered sections of 17 U.S.C.). 

16. 17 U.S.C. 1201(a)(1).

17. 17 U.S.C. 1201(a)(2) and (b).
14 COPYRIGHT ISSUES IN DIGITAL MEDIA

The DMCA details a number of activities that are exempt 

from the circumvention prohibition.18 Beyond those specific exemptions, the DMCA requires the Register of 

Copyrights to conduct a triennial rulemaking to determine whether additional activities should be exempt from 

the prohibitions.19

Safe-Harbor and Notify-and-Takedown Provisions. The 

safe-harbor provision of the DMCA reflects an early attempt to clarify an ISP’s potential liability for contributory copyright infringement. It stipulates that ISPs cannot be held liable for copyright infringement for either 

the transmission or the storage of copyright-infringing 

materials on their networks or for supplying links to infringing material, provided that the ISP fulfills certain 

obligations. To benefit from the safe-harbor provision, for 

example, the ISP must not have had prior knowledge of 

the copyright infringement. Further, in the event that 

copyright-infringing material “resides” on its network, 

the ISP must comply with the notify-and-takedown 

terms of the DMCA. The DMCA spells out the measures 

that an ISP must take to ensure that it will be promptly 

informed about the presence of copyright-infringing material on its network. Once alerted to such copyright infringement, the ISP must remove (or “take down”) from 

its network the copyright-infringing materials and notify 

the responsible party of their removal. Finally, upon receiving a subpoena issued by a court clerk, the ISP must 

disclose to the copyright owner the identity of the parties 

suspected of copyright infringement on its network.20

Technology’s Continuing Challenge

to Copyright Law

The tension between copyright owners and consumers 

brought about by the digitization of creative content continues to grow as computing equipment becomes more 

pervasive and the means of reproducing and distributing 

copyrighted materials in digital form become more powerful and accessible.

Technological advance is outpacing existing digital copyright legislation in two important dimensions. First, because it enables consumers to enjoy creative works in new 

ways while expanding the potential scope of copyright 

owners’ control over their work, technological advance 

increasingly calls into question both the privileges of consumers and the exclusive rights of copyright owners. Second, it raises new obstacles to the efforts of copyright 

owners to limit and penalize copyright infringement. The 

Congress attempted to accommodate fair use and other 

consumer concerns, such as personal privacy on the Internet, in crafting the anticircumvention and notify-andtakedown provisions of the DMCA. However, technological progress is placing growing strains on whatever balance had previously been achieved between the rights of 

copyright owners and the interests of consumers. 

Diminished Control over Copyrighted Works 

As computer technology that allows music tracks to be 

“ripped” from a compact disc (CD) and transferred to a 

computer or other digital device has become widely available, making copies of digital music files without authorization from the copyright owner has become quite popular. However, copyright law does not explicitly exempt 

that particular type of copying—or any type of digital 

copying—from copyright infringement (see Box 2-3). 

Indeed, copyright owners, concerned about losing control over subsequent uses of their works, increasingly envision the use of copy-control techniques for distribution 

of digital content. Copy-control techniques are already 

applied to CDs and DVDs distributed in Europe and to 

DVDs distributed in the United States. Copyright owners favor using those techniques for music distributed on 

CDs in the United States, but consumers accustomed to 

18. Exempt activities include access to copyrighted material for librar- ripping audio files from the CDs they purchase are conies, archives, and educational institutions to make an acquisition 

appraisal; law enforcement actions; reverse engineering to achieve 

interoperability of software programs; some encryption research; 

protection of personally identifying information; and security testing.

19. The standard for exemption is whether “persons who are users of a 

copyrighted work are, or are likely to be in the succeeding 3-year 

period, adversely affected by the [circumvention] prohibition [of 

1201(a)(1)] in their ability to make non-infringing uses under this 

title of a particular class of copyrighted works.” 17 U.S.C. 

1201(a)(1)(C).

20. To obtain a subpoena under the DMCA, copyright owners must 

identify the work(s) on which copyright is being infringed and the 

material that is claimed to be infringing; supply the location of 

that material on the ISP network and contact information for the 

copyright owner; provide statements attesting to the accuracy of 

the information provided (particularly the status of copyright 

owner or agent), as well as a “good faith belief” that the copyright 

in question is being violated; and make a sworn statement that the 

information obtained will be used only for copyright-protection 

purposes. 17 U.S.C. 512(h). 
CHAPTER TWO COPYRIGHT LAW AND TECHNOLOGICAL CHANGE 15

testing such measures. In an effort to make it difficult or 

disadvantageous to thwart copy-control measures, owners 

of copyright on music and movies advocate maintaining, 

if not strengthening, the DMCA’s prohibition against the 

circumvention of technologies that either control access 

to, or prevent infringing uses of, copyrighted works.21

Copyright owners’ concerns about control of subsequent 

uses of their work are not limited to the Internet. Advances in networking technologies and electronic media 

devices allow consumers today to enjoy the prospect of 

attractive new applications for digital content. Localized 

networking, for example, may allow movies to be transferred from room to room within a single household, an 

Box 2-3.

Is It Legal to Use a Computer to Make a Copy of a Music CD?

Although the courts have not yet determined 

whether copying a digital music file for personal use 

is a copyright infringement, they have ruled that a 

commercial entity’s copying of a digital music file to 

facilitate personal use does constitute copyright infringement. 

Copying for Personal Use

The Audio Home Recording Act (AHRA) of 1992 

grants an exemption from copyright-infringement 

suits for the use of an approved digital audio recording device to make personal copies of musical recordings. Many observers invoke the decision in the Recording Industry Association of America’s (RIAA’s) 

case against Diamond Multimedia Systems to support their view that using a computer to make personal copies of digital music files is not copyright infringement. In that case, the U.S. Court of Appeals 

for the Ninth Circuit considered allegations that Diamond Multimedia Systems had violated the AHRA 

in its manufacture of portable (Diamond Rio) MP3 

players, which make copies of digital audio files from 

a computer hard drive and store them for replay. The 

Court found that, since the MP3 player in question 

could only make reproductions of a digital music file 

through an attached computer and a computer did 

not qualify as a “digital audio recording device” under the AHRA, the manufacturer was not required 

by the AHRA to incorporate technology to prevent 

serial copying or to pay royalties.1

However, the Court only addressed whether the 

MP3 player was covered by the AHRA; it did not explicitly address whether copying from computers for 

personal use constitutes a general limitation—as an 

element of fair use—on the exclusive rights of copyright owners. Hence, that case did not establish a 

general precedent for personal copying but interpreted a specific clause of copyright law in the context of a particular type of digital copying.2

Copying for Commercial Use

The courts have, however, found that third-party 

copying for commercial use—in this case, to facilitate personal use by individual consumers—does not 

qualify as fair use. In UMG Recordings v. MP3.COM,

the U.S. District Court for the Southern District of 

New York found MP3.COM guilty of infringement 

for making unlicensed digital copies of music files 

for storage on Internet servers so that the company 

could provide owners of legally purchased compact 

discs remote access to music from those CDs.3

1. Recording Industry Ass’n of America, Inc. v. Diamond Multimedia Systems, Inc., 180 F.3d 1072 (9th Cir. 1999).

2. However, the ruling did point out that “the Rio’s operation 

is entirely consistent with the [AHRA’s] main purpose—the 

facilitation of personal use,” and cited the Senate report 

accompanying the AHRA, which stated that “[t]he purpose 

of [the Act] is to ensure the right of consumers to make analog or digital audio recordings of copyrighted music for their 

private, noncommercial use.” See S. Rep. 102-294. 

3. 109 F. Supp. 2d 223 (S.D.N.Y. 2000).

21. However, copyright owners have also indicated their willingness to 

accommodate limited consumer copying. See “Deal Set on Allowing Limited DVD Copying,” CNN.com, July 14, 2004; and John 

Borland, “CD Lock Loosened for Freer Copying,” CNET 

News.com, January 22, 2004.
16 COPYRIGHT ISSUES IN DIGITAL MEDIA

apartment building, or a college dormitory. Digital video 

recorders may change how television content is paid for 

and marketed (see Box 2-4). If copyright owners cannot 

maintain control over their works in digital form, they 

may not be able to charge for such uses and, in some scenarios, could face economic worries similar to those generated by the illicit file-swapping of audio files on the Internet.22

The first sale clause, which permits distribution but not 

reproduction of previously sold copyrighted works, provides another example of how digitization has changed 

the way consumers and copyright owners make use of 

creative works.23 Consumers exercise their first sale rights 

when, for example, they sell, loan, or give away a lawfully 

acquired printed book or music CD. When copyrighted 

material is transferred over the Internet, however, an electronic copy is created; consequently, that transfer constitutes infringement unless it is authorized by the copyright 

owner. The first sale clause, therefore, has limited application for creative works in digital form.24

Copyright owners have also tried to avoid the first sale 

clause altogether by licensing rather than selling physical 

products containing digital works. Although a legally effective license can avoid creation of rights under the first 

sale clause, mass market licenses—for example, those on 

widely distributed software products—are not traditional 

“offer-and-acceptance” licensing agreements. The courts 

have not yet ruled on the viability of mass market licensing practices intended to avoid the first sale clause.25

The increasing use of the Internet to distribute copyrighted materials will probably lead to new licensing pracBox 2-4.

A Particular Technology’s Challenge to Fair Use

In Sony v. Universal Studios, the Supreme Court held 

that time-shifting of television viewing through videotape is fair use and, therefore, devices for recording 

television broadcasts do not contribute to copyright 

infringement.1

 Some digital equipment used for 

time-shifting, such as SonicBlue’s ReplayTV units, 

enables consumers to automatically skip or remove 

commercials and to send copies of a recorded program over the Internet. That capability poses a serious economic threat to copyright owners of televised 

content, who initiated litigation against SonicBlue, 

which has since declared bankruptcy. Even though 

other digital video recorder (DVR) models do not 

currently promote the contested features of ReplayTV units, the technology that enabled those and 

other potentially copyright-infringing functions remains available to DVR manufacturers, and some 

have recently announced plans to offer those features 

in the near future.2

 In addition, forthcoming DVR 

models will offer larger hard drives and remote, virtually real-time programming, further weakening 

broadcasters’ ability to shape their programming 

schedule to attract particular types of viewers and, 

hence, to earn advertising revenues.3

1. 464 U.S. 417 (1984).

2. See Jonathan Krim, “TiVo’s Plans Lead to Fight on Copyrights,” Washington Post, July 22, 2004.

3. See “A Farewell to Ads,” The Economist, April 17, 2004, pp. 

61-62; and Julia Angwin, Peter Grant, and Nick Wingfield, 

“In Embracing Digital Recorders, Cable Companies Take 

Big Risk,” Wall Street Journal, April 26, 2004. 

22. See “A Real Hollywood Horror Story,” BusinessWeek Online, 

March 23, 2003 (available at http://www.businessweek.com

/magazine/content/03_10/b3823088_mz063.htm?c

=bwinsidermar1&n=link2&t=email).

23. 17 U.S.C. 109(a).

24. See Joseph P. Liu, “Owning Digital Copies: Copyright Law and 

the Incidents of Copy Ownership,” William and Mary Law 

Review, vol. 42 (2001), pp. 1251-1252.

25. A notable example is a software manufacturer’s attempts to prevent the unbundling of components of a software suite at resale. 

In that case, the U.S. District Court for the Central District of 

California held that the restrictive licensing practices of the defendant software maker were unenforceable, but it did so on a very 

narrow basis. See Softman Products Co., LLC v. Adobe Systems, Inc.,

171 F. Supp. 2d 1075 (C.D. Cal. 2001).
CHAPTER TWO COPYRIGHT LAW AND TECHNOLOGICAL CHANGE 17

tices as copyright owners respond to consumers’ frustration with legal constraints on their ability to transfer 

copyrighted material in digital form and as creators experiment with new product-licensing practices. As a consequence, additional legislative or judicial scrutiny may 

be required. For example, efforts to standardize licenses 

for software acquired across states through the Internet, 

embodied in the Uniform Computer Technology Information Act in 1999, have proven contentious, and only a 

few states have ratified it so far. 

A related challenge to copyright law stems from the growing incorporation of computer chips, and the software 

that regulates them, into a variety of products. To the extent that such software is protected by copyright, an original equipment manufacturer may try to use the accesscircumvention prohibition of the DMCA to prevent rivals from making their components interoperable with 

those of the original product. Intentionally or not, such 

efforts could stifle the innovation that emerges from 

broad experimentation by users.26

For example, in Lexmark International v. Static Control 

Components, currently before the U.S. District Court, 

Eastern District of Kentucky, Lexmark charged that 

Static Control Components violated the DMCA by circumventing the authentication feature that controls access to the copyrighted software that regulates interaction 

between the printer and the print cartridge.27 That circumvention enabled Static Control Components to offer 

replacement cartridges that competed with those of Lexmark, the original equipment manufacturer. Some observers have suggested that such an application of the 

DMCA is contrary to the law’s intention and threatens 

competition in numerous component markets, such as 

parts for automobiles, as well as technological innovation 

that relies on the ability to reverse engineer new products.28

New Obstacles to Copyright Enforcement

Perhaps the most well-known illustration of information 

technology’s current challenge to copyright enforcement 

is the unauthorized sharing of digital music files on the 

Internet through peer-to-peer (P2P) networks. Since the 

late 1990s, software has been readily available from retailers and over the Internet to rip audio files from CDs and 

then store them, typically in compressed digital versions 

(MP3 format) on personal computers. During that period, both the computer processing power available for 

audio file conversion and the amount of storage space 

available on personal computers have expanded significantly. Those years also witnessed a sizable increase in individual access to broadband Internet connections and 

the emergence of P2P networks, which allow individual 

computer users to make files on their hard drive available 

to others through the Internet. As a result, unauthorized 

copying, storing, and sharing of digital files has become 

inexpensive and easy.

P2P file-sharing has grown dramatically in recent years 

(see Box 2-5). According to one estimate, an average of 8 

million users were online and sharing 10 million gigabytes of data on those networks at any given time during 

June 2004.29

In contrast, the value of music sales in the United States 

fell approximately 4 percent in 2001, 8 percent in 2002, 

and 6 percent in 2003 (see Figure 2-1). The persistence 

and magnitude of those revenue declines are exceptional 

in recent history and are regularly attributed to unauthorized file-sharing across P2P systems.

However, some people argue that the impact of P2P sharing on music sales is overstated. They emphasize that the 

growth in music sales during the mid-1980s and early 

1990s was unsustainable for several reasons: the introduction of the CD format; high CD prices; a reduction in 

the number of music titles available for purchase; and 

competition from other entertainment, such as DVDs

26. See Hal Varian, “New Chips Can Keep a Tight Rein on Consumers,” New York Times, July 4, 2002. 

27. 253 F. Supp. 2d 943 (E.D. Ky. 2003).

28. In the latest triennial rulemaking required by the DMCA, Static 

Control Components requested an anticircumvention exemption. 

On October 28, 2003, the Register of Copyrights denied Static 

Control’s request, pointing out that the DMCA’s statutory exemption for reverse engineering provided sufficient guidance for the 

courts to make a determination about copyright infringement. 17 

U.S.C. 1201(f). Regardless of the legal outcome, the case of Lexmark International v. Static Control Components illustrates the 

potential for unintended consequences from modifying copyright 

law in the digital era. 

29. See John Borland, “Survey: Movie-Swapping Up; Kazaa Down,” 

CNET News.com, July 13, 2004 (available at http://

news.com.com/2100-1025_3-5267992.html).
18 COPYRIGHT ISSUES IN DIGITAL MEDIA

and electronic games. Indeed, even music industry executives have recently begun to acknowledge that file-sharing 

may not be the entire cause of declining sales.30

The popularity of music file-swapping shows the ease 

with which copyrighted material can be obtained and redistributed on the Internet today. The rate of data transfer that the Internet allows currently makes the distribution of movie-length video files much more timeconsuming than that of audio files; hence, illicit sharing is 

less common for video content than for audio files. 

Nevertheless, movie and software companies (especially 

computer-game makers) are increasingly worried that 

technological advances in digital compression, transmission, and file-sharing will soon lead to piracy of their 

copyrighted content.31 According to the Motion Picture 

Association of America, the number of Web sites offering 

pirated movies increased from 143,000 in 2002 to approximately 200,000 by the end of 2003. In March 2004, 

video files accounted for 31.9 percent of bytes transmitted over P2P networks, up from 16.4 percent in March 

2003.32

Although the DMCA explicitly provided copyright owners with the means to enforce their intellectual property 

rights on the Internet, the law was promulgated in an era 

of server-based rather than P2P network distribution. As 

a result, copyright owners’ ability to prosecute unauthorized reproduction and distribution of copyrighted materials on the Internet by suing the enabling file-sharing 

services has come into question. Such measures were successful against the Napster service, which used its own 

Box 2-5.

Peer-to-Peer File-Sharing Networks

Peer-to-peer (P2P) networks allow individual computers to share files on the Internet. The original 

P2P networks were administered by a central server, 

which managed access to the files available on the 

network. Users who sent a search request to the central server for a particular file, such as a music track, 

would receive a list of available files and their location on the P2P network. The user would then 

download the file directly from one of the individual 

computers connected to the network.

Current P2P networks, in contrast, operate in a decentralized fashion—that is, without a central server. 

The software that connects each computer on the 

network conducts the search-and-retrieval process. 

When a user searches for a file, the request is transmitted sequentially to individual computers connected to the P2P network. The responses from each 

computer are then sent to the requester, who receives 

a list of files and locations available for downloading.1

Because P2P networks enable unauthorized filesharing, they are currently a significant source of 

copyright-infringement concerns. Eventually, however, P2P technology is expected to make the Internet less vulnerable to disruption and to allow greater 

efficiency in transferring data and information online—for example, by facilitating collaboration 

among a company’s geographically dispersed workers or by reducing the cost of voice calling.2

1. See Appendix II, “Description of File-Sharing and Peer-toPeer Networks,” in General Accounting Office, File-Sharing: Selected Universities Report Taking Action to Reduce 

Copyright Infringement, GAO-04-503 (May 2004), pp. 24-

29. 

2. See Simson Garfinkel, “Pushing Peer-to-Peer,” Technology 

Review, October 3, 2003.

30. See Neil Strauss, “Executives Can See Problems Beyond FileSharing,” New York Times, September 9, 2003. For links to recent 

academic research on Internet file-sharing, see http://www.

utdallas.edu/~liebowit/intprop/main.htm.

31. See, for example, “Hollywood’s Piracy Epic,” FT.com, September 

12, 2003.

32. See Lorenza Muñoz and Jon Healy, “Pirated Movies Flourish 

Despite Security Measures,” Los Angeles Times, December 4, 2003; 

and “Streaming Media,” Wired, June 2004 (available at http://

wired.com/wired/archive/12.06/free).
CHAPTER TWO COPYRIGHT LAW AND TECHNOLOGICAL CHANGE 19

Figure 2-1.

Annual Change in Value of Recording Industry Shipments, 1987 to 2003

(Percentage change from previous year)

Source: Recording Industry Association of America.

computer servers to direct file requests to available content on individual computers; however, newer P2P services do not rely on centralized servers but rather on enabling software that is not administered by a single entity. 

Further, in the recent case of MGM Studios v. Grokster, 

the U.S. District Court for the Central District of California held that because the Grokster file-sharing service 

had substantial noninfringing uses, it was not liable for 

contributory copyright infringement.33 That ruling is 

currently being appealed.

As a result of the proliferation of P2P file-sharing, individuals rather than larger, Web-hosted entities have become the target of the subpoena provisions of the 

DMCA. Until recently, the courts have upheld the ability 

of copyright owners to obtain from ISPs identifying information about individuals suspected of infringing 

copyright. Beginning in September 2003, the Recording 

Industry Association of America (RIAA) used that information to file 382 lawsuits. However, that subpoena 

power was checked—at least temporarily—by a December 19, 2003, decision by the U.S. Court of Appeals for 

the District of Columbia Circuit.34 The Court ruled in 

favor of Verizon Internet Services, Inc., which was contesting the application of the DMCA’s subpoena provisions to cases of copyright infringement in which the infringing material resided not on an ISP’s server but, 

rather, on an individual’s PC. 

In response, the RIAA initiated “John Doe” lawsuits, 

which target groups of suspected copyright infringers. As 

of June 22, 2004, the RIAA had filed 3,047 such lawsuits. Only after considering the merits of each lawsuit 

will the courts issue a collective subpoena for identifying 

information on individuals in the group. This contrasts 

sharply with the options for legal action thus far afforded 

by the DMCA’s subpoena provisions, under which identifying information was obtained first and individual lawsuits filed thereafter. 

1987 1989 1991 1993 1995 1997 1999 2001 2003

-10

-5

0

5

10

15

20

25

33. 259 F. Supp. 2d 1029 (C.D. Cal. 2003). 

34. Recording Industry Ass’n of America, Inc. v. Verizon Internet Services, Inc., 351 F.3d 1229 (D.C. Cir. 2003). That decision is currently being appealed, with both the U.S. Department of Justice 

and the Copyright Office filing legal briefs in support of the 

RIAA.
20 COPYRIGHT ISSUES IN DIGITAL MEDIA

Copyright owners may attempt to obtain subpoenas under the DMCA from other courts, or they may petition 

the Congress to revise copyright law to allow explicitly for 

subpoenas in the context of P2P networks. Given concerns for individual privacy, the subpoena provisions of 

the DMCA are likely to remain controversial.

Finally, enforcement abroad is becoming increasingly important for U.S. copyright owners. Manufacturing advances are enabling even small-scale piracy operations to 

produce large numbers of unauthorized CDs and DVDs. 

Such illicit activity is particularly common in Asia, where 

it is often connected to organized crime. 

Piracy abroad has become increasingly harmful to copyright owners of movies as well as music. For example, the 

Motion Picture Association of America claims that global 

piracy of DVDs cost it $3.5 billion in revenues during 

2003. Another concern of U.S. copyright owners is increasing Internet penetration in Europe and Asia, where 

copyright laws are in some ways less stringent than those 

in the United States.35 As a consequence of those developments, the protection of intellectual property has become prominent in both multilateral and bilateral trade 

negotiations between the United States and other nations, most notably China and other developing countries.

To better understand the economic rationale for copyright law and the economic interests of copyright owners 

and users of copyrighted materials, the next chapter addresses the role of property rights in the economy. In particular, it examines why creative works, such as those covered by copyright law, call for a different system of 

property rights than those applied to most other types of 

property. It also considers, from an economic perspective, 

how markets for copyrighted works in digital form might 

evolve to provide broad benefits to society.

35. See Geoffrey A. Fowler, “Hollywood’s Burning Issue Is Piracy of 

DVDs and CDs,” Wall Street Journal, September 18, 2003; and 

Mark Landler, “U.S. Is Only the Tip of Pirated Music Iceberg,” 

New York Times, September 26, 2003.
3

Copyright and the Economics of

Intellectual Property Regulation

Copyright is a subset of the larger category of 

property rights that govern both tangible and intangible 

property. Intangible property—also known as intellectual 

property—includes creative works, which are protected 

by copyright and trademark law, as well as technical and 

scientific works, which are protected by patent law. Welldefined and -administered property rights are fundamental to the functioning of market economies. The ownership of traded goods and services—and the recourse that 

the parties have in a dispute arising from any exchange—

must be established for arms-length transactions among 

individuals to be feasible. In addition, a variety of decisions—on whether to save and invest, for example, or to 

undertake education, engage in skill building, or pursue 

research and development—depend on the likelihood of 

being able to claim the wealth that those activities may 

eventually generate.

Government policy that regulates and enforces property 

rights, as copyright law does for creative works embodied 

in a tangible means of expression, plays a crucial role in 

economic well-being. However, the unique features of intellectual property argue for a different type of government regulation than that applied to most other forms of 

tangible property.

The Regulation of Intellectual Property

One way to assess the performance of a particular set of 

property rights is to examine its capacity to promote economic efficiency. The markets for most goods and services can achieve an efficient allocation of resources under 

a standard set of property rights and regulations. Some 

goods and services, however, have characteristics that require additional regulations so that a private market can 

generate an efficient outcome. Creative work is one of 

those products and, as a consequence, it is subject to a 

different property rights and regulatory regime than are 

most tangible goods.

A general condition of efficiency is that the marginal cost 

of producing any good or service should equal society’s 

marginal valuation of it. If it does not, society could obtain valuable output by reallocating some of the resources 

at its disposal. Efficiency requires that the production of 

goods and services whose marginal value to consumers is 

greater than the additional resource cost to produce them 

should be increased at the expense of goods and services 

that impose a cost on society that is greater than their valuation by consumers.

The basic property rights that lead to efficient outcomes 

in most markets for goods and services would not produce an efficient outcome in the market for creative 

works. Two distinctive features of creative works account 

for this result. First, once a work is created, the cost of its 

reproduction and distribution will typically not reflect 

the expenses incurred during its creation. Prices that were 

set equal to the low marginal cost of reproducing and distributing creative works would—once those works had 

been created—efficiently supply them to consumers. The 

revenues generated by those prices, however, would not 

compensate creators economically for their efforts to produce those works in the first place. As a result, a less-thanefficient amount or quality of creative works would be 

produced.

CHAPTER
22 COPYRIGHT ISSUES IN DIGITAL MEDIA

As the costs of reproduction and distribution of creative 

works in digital form continue to fall, copyrighted material can be made available to consumers at a very low 

marginal cost. Copyrighted works are becoming effectively “nonrivalrous” in consumption—that is, when a 

person acquires a creative work in digital form, that individual does not diminish its availability to other consumers. 

Once the costs of creating a software program or computer game have been incurred, for example, those files 

can be transferred to a CD-ROM or distributed over the 

Internet very inexpensively and at a cost that continues to 

fall with ongoing advances in digital reproduction and 

distribution technologies. Pricing that product at the low 

marginal cost of supplying it would not allow the software manufacturer to recoup the entire expense of production and distribution and would lead to an inadequate supply of new software products. By granting 

copyright owners an exclusive right for a limited period 

of time, copyright law enables software manufacturers 

and other producers of intellectual property, such as publishers and the recording and movie industries, to charge 

prices above marginal cost to recoup their total costs. 

Copyright law thereby enhances the supply of creative 

products that would be brought to market without copyright protection.

The second distinguishing characteristic of creative work 

is that it is often quite difficult for society to prevent a 

person from consuming the work once it is created. Some 

types of intellectual property are particularly vulnerable 

to theft or misuse. Once a copyrighted photograph or 

work of graphic art is published, for example, a reproduction can be readily made and redistributed without the 

authorization of the copyright owner. Licensing terms for 

the use of some types of intellectual property are often 

more strict than those for tangible property. For works of 

visual art, for instance, copyright owners have exclusive 

rights not just to reproduce, distribute, and make derivative works, but also to receive attribution whenever a particular image is published.

In myriad ways, creative works today supply the intellectual foundation for future creativity. In cases where the 

benefits of the knowledge underlying creative works and 

the works themselves are cumulative, it may not be feasible for society to prevent the consumption of creative 

works. For example, readers of fiction by a particular 

writer may benefit from that author’s knowledge of earlier works of literature, even though the readers themselves have not purchased those books. Because of those 

“spillover effects,” copyright owners may not be able to 

appropriate all of the gains to society from the underlying 

creative efforts. 

The socially beneficial element of that circumstance argues for eventually making intellectual property widely 

available. The compromise struck in property rights governing creative works, as noted, is to place a time limit on 

the exclusive rights of the creator or owner of intellectual 

property. Once the work enters the public domain, its 

price should reflect the low marginal cost of production 

and distribution. Charles Dickens’s A Tale of Two Cities, 

for example, can be bought at a price far lower than that 

of even the last entry on the current bestsellers list.

Efficiency in the distribution of a copyrighted work occurs when the marginal purchaser pays a price equivalent 

to the incremental cost of providing that product. Current copyright law does not produce such prices, however; the need to ensure an adequate return for creators 

leads to prices for creative works that, over the life of the 

copyright, exceed the costs of reproduction and distribution. As a result, some consumers who value the product 

at less than the market price—yet would be willing to pay 

a higher price than the marginal cost of supplying it—

may be priced out of the market until the work enters the 

public domain. Hence, copyright law currently accepts 

some static inefficiency (that is, copyrighted works may 

not be distributed as widely as is economically feasible) in 

the interest of beneficial dynamic effects (that is, in the interest of getting those works created in the first place).

From the point of view of economic efficiency, the benefits and costs to society of specific copyright laws have 

probably always been less than perfect. Today, however, 

digital technologies may offer the prospect of improving 

the benefits and costs of the copyright regime by allowing 

producers to adopt refined pricing practices that permit 

more consumers to purchase creative products at prices 

that approximate their willingness to pay while, at the 

same time, enabling copyright owners to realize higher 

revenues for their work and thereby obtain greater resources for future creative efforts.
CHAPTER THREE COPYRIGHT AND THE ECONOMICS OF INTELLECTUAL PROPERTY REGULATION 23

More Efficient Copyright Markets: 

Price Discrimination and Technology

Current copyright markets are unlikely to produce an 

economically efficient outcome. Instead, the prices for 

creative products, which are set in part by current copyright laws and policies, are likely to produce an inadequate supply of those products or to overcharge for them. 

Yet economic analysis of markets with attributes similar 

to those of intellectual property—where pricing at marginal cost calls forth too little supply—yields a potential 

solution that produces an efficient outcome called “perfect price discrimination.” Under perfect price discrimination, each consumer is charged a price that corresponds 

to what the individual is willing to pay for a particular use 

of the intellectual property in question. 

Using that type of pricing, the problem of covering the 

cost of creative products can be solved by charging a 

higher price to those consumers with relatively strong demand for their products. Similarly, the objective of wide 

dissemination can be achieved by charging a reduced 

price to those consumers with a lower demand for the 

product. Price discrimination can occur only when consumers in a market with higher prices are unable to purchase the identical product in markets where lower prices 

are charged. Yet the basic economic idea behind price discrimination holds if variants of the original product are 

offered. Advances in information technologies increase 

the potential for offering numerous variants of products 

with the same underlying creative content and thereby 

enhance the feasibility of such pricing arrangements. 

Although markets for creative content in digital format 

may offer the prospect of an improved balance between 

the returns necessary to encourage new creative effort and 

the wide availability of creative works, those markets are 

only now emerging and their economic efficiency is not 

foreordained. Markets governed by rules consistent with 

digital rights management need not, in practice, produce 

a more efficient outcome.

Price Discrimination and Digital Rights 

Management Technology

Developments in DRM technology suggest that perfect 

price discrimination—or simpler variants known generally as differential pricing—may soon become feasible for 

copyrighted works in digital format. In particular, DRM 

would enable copyright owners to charge a price for their 

creative works that varied according to the particular 

use(s) made of them. Literally, consumers would pay a 

price that depended on the amount of “rights” that they 

were able to exercise over a copyrighted work in digital 

form. 

Take, for example, two individuals who purchase a music 

CD—one simply to listen to it on a standard CD player 

and the other to listen but also to make copies of the CD 

for transfer to a digital device.1

 Although both consumers 

would pay the same price for the CD, one of them would 

most likely enjoy greater benefits. Even though the cost, 

at the margin, of reproducing the musical recording 

physically on a CD is minimal, consumers who envision 

more limited use of the CD may be priced out of that 

market. On the supply side, some creative music projects 

that would be distributed on a CD may not be undertaken because setting a common price for all units would 

not yield adequate revenues. In that scenario, differential 

pricing would be more likely to generate sufficient revenues. The efficient outcome is one of perfect price discrimination in which each consumer pays exactly his or 

her own valuation of each type of use.2

Potential Qualifications 

Notwithstanding its strengths when viewed in the context of economic theory, several potentially important 

qualifications to the advantages of perfect price discrimination and DRM technologies should be noted.

Incentives to Create. Although perfect price discrimination may be efficient in a static sense—that is, in distributing a creative work among as many consumers as is economically feasible—its dynamic effects on creativity are 

less clear. By enabling copyright owners to engage in differential pricing and thereby realize higher revenues for 

their work, DRM should provide greater resources for future creative efforts. However, those greater resources 

may not always lead to an increase in the number or quality of creative works that improve social welfare. 

1. For another example relevant to copyrighted works in digital 

form, see Hal R. Varian, “Buying, Sharing, and Renting Information Goods,” August 5, 2000, available at http://www.sims.

berkeley.edu/~hal/Papers/sharing.pdf.

2. See the discussion of the Lindahl price mechanism in Agnar 

Sandmo, “Public Goods,” in John Eatwell, Murray Milgate, and 

Peter Newman, eds., New Palgrave Dictionary of Economics (London and Basingstoke: Macmillan Press, 1987), pp. 1061-1066. 
24 COPYRIGHT ISSUES IN DIGITAL MEDIA

Some creative works, for example, are too new or demanding to be commercially successful. Those works can 

continue to be funded by public resources or private endowments, and the creative output they represent will 

not be altered by the introduction of market-based pricing schemes.

In addition, relatively little is known about what motivates people to engage in creative activity and how those 

influences differ from the perhaps more pecuniary motivations of those who acquire the copyright to creative 

works for purposes of reproduction and distribution. In 

other words, economic theory has not yet specified a 

“creative production function.” That is not to argue that 

copyright protection is not important to the financial 

ability of individual creators to devote themselves to their 

craft. Economists may with some confidence predict that 

abolishing copyright protection altogether would reduce 

the level and quality of creative output.3 However, they 

cannot easily predict exactly how a less dramatic change 

in compensating copyright owners—through differential 

pricing schemes, for example—would affect the number 

or quality of creative works being produced and distributed. 

Some commentators emphasize the distinction between 

the creation of a work and related activities such as its distribution. Both creators and distributors may be owners 

of copyrighted works, but the two groups differ in their 

objectives and hence the importance that they place on 

various copyright protections. Creators, for example, may 

be more likely than distributors to be motivated by nonpecuniary factors—creative drive, a desire for attribution 

and recognition, and the need to ensure the integrity of 

their work, for example—while distributors may be more 

likely to respond to monetary incentives. As a result, the 

existence of copyright—in particular, exclusive rights 

over subsequent use—may simply motivate distributors 

of copyrighted works to engage in marketing and promotional activity, which do little to ensure the future supply 

of creative works.4

Even if creators were to respond strongly to economic incentives, perfect price discrimination in digital copyright 

markets—combined with the exclusive rights that copyright law already provides to copyright owners—will not 

necessarily produce greater beneficial dynamic effects. It 

is possible, for example, that too many creative projects 

will be undertaken. Allowing copyright owners to exploit 

differential pricing for the duration of the copyright protection that U.S. law grants them may generate returns 

that exceed those from, say, education or other socially 

beneficial activities. The supply of aspiring musicians, 

moviemakers, and writers could increase at the expense of 

the supply of doctors or scientists.5

Deviations from Perfect Price Discrimination. Where 

perfect price discrimination is not feasible, other types of 

differential pricing arrangements are likely to emerge. 

One particular pricing strategy is likely to arise in markets 

for creative content in digital format. That strategy applies prices that vary not across individuals but rather 

across groups of consumers on the basis of their shared 

type of use (listening to versus making copies of music 

tracks, for example, or renting versus buying a book or 

movie). The criterion for a more efficient outcome from 

such differential pricing arrangements is relatively 

straightforward: the loss to customers who find themselves priced out of the market for a relatively feature-rich 

product variant—a product identical to one they were 

able to purchase when it was available as a uniform commodity—must be offset by the gains to customers who 

are newly able to consume a lower-priced variant of the 

product.6

Such differential pricing is already widely applied to some 

digital copyrighted works. Because of the low marginal 

3. For a discussion of how widespread copyright infringement may 

reduce creative activity in an economy, see Ien Cheng, “Pirates 

Drain the Life from the HK Film Industry,” Financial Times,

April 13, 2004; and Graham Gori, “In Mexico, Pirated Music 

Outsells the Legal Kind,” New York Times, April 1, 2002. For a 

historical example, see the discussion of the removal of copyright 

protection in post-revolutionary France in part 3 of Charles C. 

Mann’s “Who Will Own Your Next Good Idea?” Atlantic 

Monthly, September 1998, pp. 57-82. 

4. See Mark S. Nadel, “How Current Copyright Law Discourages 

Creative Output: The Overlooked Impact of Marketing,” Berkeley 

Technology Law Journal, vol. 19 (Spring 2004), available at http://

papers.ssrn.com/sol3/papers.cfm?abstract_id=489762.

5. See Glynn S. Lunney, Jr., “Re-examining Copyright’s IncentiveAccess Paradigm,” Vanderbilt Law Review, vol. 49 (1996), pp. 

483-656.

6. For a more complete, theoretical discussion of differential pricing 

regimes, see Jean Tirole, The Theory of Industrial Organization 

(Cambridge, Mass., and London: MIT Press, 1988). For an 

assessment of the efficiency and welfare impacts of differential 

pricing on a variety of markets for creative works, see Michael J. 

Meurer, “Copyright Law and Price Discrimination,” Cardozo Law 

Review, vol. 23 (November 2001).
CHAPTER THREE COPYRIGHT AND THE ECONOMICS OF INTELLECTUAL PROPERTY REGULATION 25

cost of distribution, moreover, that differential pricing 

can lead to greater consumption. The per-user cost of site 

licenses for software products, for example, often declines 

with the number of users at the site. Consequently, the 

client has an incentive to purchase a license for users who 

would make only marginal use of the software. Since the 

cost to produce and distribute the software is independent of the number of users, software companies can reduce the per-user price to sell as comprehensive a license 

as possible to an organization and still profit. Another 

type of differential pricing of software products takes the 

form of price rebates for customers who purchase particular bundles of software packages. Again, the price rebate 

provides customers with an incentive to purchase additional software packages for which they might not be 

willing to pay the stand-alone price.

Concerns About Competition. To prevent differential 

pricing schemes from forcing existing consumers to purchase an inferior variant of a product they had purchased 

previously, diverse versions of a given copyrighted work 

in digital form must be provided. The availability of 

those variants, though, hinges on sufficient competitive 

pressures in markets for creative works. Almost by definition, however, creative products are unique: something 

that is distinctive to each either appeals to or displeases 

consumers. As a result, creative works of a given type may 

not be as interchangeable as other commodities grouped 

similarly, and competitive pressures may be weaker in 

markets for copyrighted works than elsewhere.

For example, some digital videodiscs have embedded 

technology that prevents the viewer from skipping the 

promotional materials that precede the film. Economic 

efficiency would suggest that DVDs with and without 

promotional material should sell at different prices, reflecting both the copyright owner’s value from advertising and viewers’ willingness to pay to avoid the delay in 

getting to the featured programming. Competition in the 

market for movies in DVD format should produce that 

outcome. However, to the extent that movies are poor 

substitutes for one another, such competitive pressures 

may be weak. For example, distributors of popular movies may simply opt not to offer DVDs without promotional material (because doing so would implicitly reveal 

the value of that advertising to them), leading to a less efficient outcome than the differential pricing model 

would predict.

One software maker’s recent, aborted attempt to force 

consumers to register their purchase of its popular tax 

software—an effort to circumscribe the number and type 

of installations possible from a given purchase—provides 

an illustration of a competitive outcome. Consumers resisted such restrictions on their potential use of purchased 

copyrighted material, perhaps because of the implicit 

price increase that the new installation constraint represented. Even though the previous price presumably included some premium to recoup losses from the unauthorized copying that the new registration process was 

intended to prevent, the new sales price of that software 

was not substantially lower. Confronted with consumer 

outrage and competing products, the company rescinded 

the registration policy.7

Equity. The introduction of differential pricing schemes 

may also provoke consumers’ concerns about equity. 

Many may view the enhanced ability of copyright owners 

to profit from their works as unfair. That could be especially true for consumers who previously enjoyed creative 

material at a lower price than they would have been willing to pay but now, under a differential pricing scheme, 

must pay the higher price that corresponds to their 

greater valuation. The excess benefit in consumption over 

purchase price that those consumers enjoyed is transferred to copyright owners.8 At the same time, however, 

the differential pricing outcome does enable other consumers, previously priced out of that market, to purchase 

the copyrighted material. Indeed, charging customers 

with higher valuations a commensurate price is important 

both to recoup the costs of creation and to provide access 

to that creative content to consumers with lower valuations. Differential pricing benefits consumers with lower 

valuations insofar as they are no longer priced out of the 

market for that creative work, and they can enjoy a wider 

range of options when allocating their available resources. 

7. See Eric Hellweg, “Intuit’s Lesson for Microsoft and Hollywood,” 

Business 2.0, May 19, 2003 (available to subscribers at http://

www.business2.com/articles/web/0,,49577,00.html). 

8. In the case where differential pricing is applied to groups of consumers by type of use of copyrighted material, rather than to individual consumers as under perfect price discrimination, the 

monetary transfer from consumers to copyright holders is mitigated. Each group of consumers engaging in the same use of copyrighted material pays the price acceptable to the marginal 

consumer among them, even when other members of that group 

value that particular use more highly. See Hal Varian, “Differential Pricing and Efficiency,” First Monday, August 5, 1996 (available at http://www.firstmonday.dk/issues/issue2/different/).
26 COPYRIGHT ISSUES IN DIGITAL MEDIA

The larger potential revenues that copyright owners may 

realize from their creative efforts through differential 

pricing, moreover, could provide financing for additional 

creative efforts that benefit all consumers.

Technological Feasibility, Implementation, and Transaction Costs. Because markets for creative works in digital 

format are only beginning to emerge, it is unclear how 

those markets will function and whether they will impose 

costs on society that exceed the expected efficiency gains.

For example, it might be very costly to develop and implement DRM technologies powerful enough to enable 

differential pricing—that is, technologies that would either prevent copyright infringement entirely or suppress 

it to a sufficiently low level that copyright owners still 

find it in their interest to make their creative works available in digital form. Alternatively, antipiracy protections, 

such as those that currently prevent music CDs from 

working in some car stereos and computers, may impose 

unexpected burdens on consumers.9

Another consideration is the magnitude of transaction 

costs. If the consumption of creative works is priced according to each type of use, then suppliers and consumers 

may have to make different, perhaps more complex, calculations than they did previously. For example, rather 

than buying a collection of songs by a single artist on 

CD, a consumer might choose from individual tracks by 

that artist and others. How readily might the terms of use 

of a copyrighted work be renegotiated by consumers after 

their initial purchase if they subsequently chose to use the 

copyrighted material in a different way than initially envisioned? What types of payment systems will be required 

for pay-per-use business models to work, and will they introduce large transaction costs? Will different types of 

DRM technologies be interoperable and standardized, so 

that a consumer can use copyrighted materials from diverse sources and with a variety of software and digital 

processing equipment?10 More generally, will consumers 

be required to read and comply with the lengthy and 

complex licenses for using copyrighted digital products 

that they now so often ignore?

Other concerns about large transaction costs are broader. 

Will the measures that copyright owners employ to discourage illicit use of their works on the Internet—for example, “spoofing” copyrighted works with decoy files 

containing admonitions against copyright infringement—pose obstacles to Internet usage in general? A related issue is the amount of privacy that consumers will 

have to cede for a copyright owner to be able to charge 

according to the particular use that a consumer makes of 

a creative product.11

The next chapter considers in more detail the obstacles to 

resolving digital copyright disputes, along with the efficiency and equity effects of a variety of potential legislative responses to the digital copyright debate. Those responses range from allowing market forces to work 

within the existing framework of copyright law to revising copyright law in significant ways to accommodate the 

increasing digitization of creative content. 

9. See Andrew Orlowski, “Copy-Crippled CDs Launch in UK, Baffling Auntie Beeb,” The Register, February 13, 2004 (available at 

http://www.theregister.co.uk/2004/02/13/copycrippled_cds_

launch_in_uk/).

10. See Gregory T. Huang, “The Web’s New Currency,” Technology 

Review, December 2003-January 2004, pp. 28-36; and John Borland, “Stalemate on Digital Content?” CNET News.com, November 6, 2003 (available at http://news.com.com/2100-1025-

5103601.html?part=dht&tag=ntop).

11. See Robert Lemos, “Digital Rights Group Knocks ‘Trusted’ PCs,” 

CNET News.com, October 2, 2003 (available at http://

news.com.com/2100-7355_3-5085442.html?tag=fd_nbs_ent).
4

Economic Implications of

Prospective Legislative Action

Participants in the ongoing copyright debate often 

look to the Congress to resolve the dispute through legislative action. During recent sessions of Congress, bills 

have been introduced to correct perceived imbalances in 

how the benefits of creative works are distributed between copyright owners and consumers. The titles of 

some of that legislation—the Protecting Intellectual 

Property Against Theft and Expropriation Act of 2004, 

the Artists’ Rights and Theft Prevention Act of 2003, the 

Public Domain Enhancement Act of 2003, and the Digital Media Consumers’ Bill of Rights Act of 2003—indicate the concerns of copyright stakeholders. 

At the same time, legislation has been enacted that seeks 

not to redefine the basics of copyright law in the digital 

age but rather to extend current policies to digital media 

by establishing guidelines and requirements for the payment, collection, and distribution of fees to be paid to 

owners of copyright on musical works that are distributed 

via certain types of Internet transmissions.1

 Indeed, prior 

to the advent of the Internet, the Congress on numerous 

occasions created compulsory and other licensing regimes 

for the distribution of copyrighted material. Finally, policymakers always have the option of forbearance—that is, 

to wait and see whether the current copyright debate will 

be resolved by legislation already enacted, new judicial 

determinations, or market-based solutions.

The wait-and-see approach, as well as strategies that 

would enact additional legislation to bring some balance 

to the copyright scales or create licensing fees, can be 

evaluated against the standard of economic efficiency. It is 

also possible to identify which groups might gain or lose 

under those different options. Indeed, the equity consequences of different legislative approaches to the current 

copyright debate—that is, how a particular strategy 

might redistribute benefits between copyright holders 

and consumers—are often easier to infer than are the impacts on economic efficiency. The evaluation that follows 

is not an assessment of the benefits and costs of specific 

legislative proposals but rather an examination of three 

broad approaches that the Congress may wish to consider: forbearance, compulsory licensing of digital content, and revision of copyright law (see Table 4-1). 

Forbearance

The Congress may choose to wait and see if the current 

copyright debate resolves itself without further legislative 

action. This course exploits the impending increase in the 

supply of content-control technologies by the private sector, as well as new services providing creative content in 

digital format, to determine whether changes to copyright law are in fact needed. Market-based solutions 

might gain support among both copyright owners and 

consumers.

One standard for judging the effectiveness of forbearance 

is the case of the videocassette recorder. In that instance, 

many content producers viewed the new home-recording 

device as a threat to their intellectual property and consequently sought to undermine a technology that consumers were rapidly adopting. Yet ultimately, producers and 

consumers reached a consensus that defined socially and 

legally acceptable uses of the new technology.

CHAPTER

1. Small Webcaster Settlement Act of 2002 (Pub. L. No. 107-321).
28 COPYRIGHT ISSUES IN DIGITAL MEDIA

Table 4-1.

Primary Effects of Broad Options for Modifying Digital Copyright Law

Continued

Markets adapted in such a way that the net benefits of the 

production of intellectual property to society probably 

increased. 

From an efficiency point of view, once new rules were established, the market outcome was a beneficial form of 

differential pricing. Returns to producers were sufficient 

to provide a substantial supply of new content. Variants 

of essentially the same creative content expanded consumers’ options beyond going to the movie theater to 

renting or buying the videocassette. Moreover, consumers 

with a wide range of valuation of the creative product 

found prices consistent with their willingness to pay: the 

most willing consumers exercised the option to pay more 

to own the movie and view it repeatedly at times of their 

choosing, while less willing consumers exercised the option to rent the videocassette for home viewing at a lower 

price in a constrained period of time. 

Prospects for a New Social and Legal Consensus

A new social and legal consensus on the right of owners 

to defend their copyrights and the right of consumers to 

fair use is essential to the resolution of the current copyright debate. It is possible that such a consensus may be 

reached without additional legislation. 

Unauthorized use of copyrighted materials has increased 

for several reasons. First, individuals are unfamiliar with 

copyright law and the kinds of activity that constitute 

copyright infringement. In particular, consumers may

Effects on Efficiency 

Option Positive Negative Effects on Equity

Forbearance: 

Allow market forces 

to work 

Option could promote 

efficiency if copyright owners 

are able to use technologies 

that allow them to charge 

different prices for their work 

depending upon a customer’s 

willingness to pay. 

Option could result in 

additional transaction costs, as 

well as copyright enforcement 

efforts and licensing practices 

that impose economic and 

social costs.

Pricing creative works according to 

customers’ valuation could benefit 

copyright owners at the expense of those 

consumers who would pay more for 

creative works than they had under uniform 

pricing. At the same time, however, if the 

technological means available to protect 

creative works in digital form do not 

succeed in preventing widespread piracy, 

then copyright infringers could benefit at 

the expense of copyright owners. To the 

extent that such piracy reduces copyright 

owners’ revenues and hence the future 

supply of creative works, society in general 

would also be harmed. 

Compulsory Licensing: Set a fixed price 

(royalty) for the use 

of certain types of 

copyrighted works

Option could reduce 

transaction and enforcement 

costs in digital copyright 

markets.

Option could reduce efficiency 

by constraining demand for 

and supply of creative works. 

It could lead to additional 

economic costs, depending on 

the price-setting, royaltytracking, and distribution 

procedures that are used, as 

well as the source of receipts 

for compensating copyright 

owners.

If revenues for paying copyright owners are 

raised through levies on digital processing 

equipment or Internet services, the process 

could impose a redistributive tax; it is 

unclear whether royalty-tracking 

procedures would allow for equitable 

compensation of all copyright owners.
CHAPTER FOUR ECONOMIC IMPLICATIONS OF PROSPECTIVE LEGISLATIVE ACTION 29

Table 4-1.

Continued

Source: Congressional Budget Office.

have become accustomed to particular uses of copyrighted materials to which they have no explicit right under copyright law. Legal actions against consumers, such 

as those the Recording Industry Association of America 

initiated in 2003, may boost consumers’ awareness of 

copyright law. Some polling data indicate that such 

awareness is growing, so rampant illegal use of digital reproduction and transmission of copyrighted material may 

decrease in the years ahead (see Box 4-1).

The slow emergence online of licensed copyrighted materials has also contributed to their unauthorized use. Content companies claim that their reluctance to make copyrighted content available online reflects inadequate 

copyright protection and enforcement. In 2004, however, 

the availability of online music increased significantly. 

Particularly notable is the recent surge in the number of 

commercial ventures—typified by Apple Computer’s 

iTunes service—that are licensed for online music distribution.2

One reason for the emergence of online businesses offering copyrighted materials is the maturation of technologies that enable copyright owners to better control their 

content. Copyright owners can secure their works by using direct control, by impeding illicit activity, or by monitoring consumers’ usage of their works. Digital rights 

management technologies now allow copyright owners to 

secure their creative works and, at the same time, to offer 

consumers a variety of uses for them and to charge by 

type of use.3

Effects on Efficiency 

Option Positive Negative Effects on Equity

Revision of copyright 

law in favor of 

copyright owners

Reduce or eliminate 

fair use provisions

Option could increase 

opportunities for differential 

pricing and, in some cases, 

efficiency. 

Society’s gain would be limited 

to the extent that the higher 

cost of copyrighted materials 

impeded socially useful 

activities that fair use 

provisions are intended to 

facilitate.

In the near term, copyright owners would 

benefit at the expense of consumers. 

However, if the additional revenues to 

copyright owners enabled creators to 

undertake more projects, consumers could 

also benefit from the greater availability of 

creative works in the long term.

Strengthen 

enforcement

Same as above. Government-mandated 

copyright protection measures 

could impede technological 

advances.

Same as above.

Revision of copyright 

law in favor of 

consumers

Option could reduce 

transaction and enforcement 

costs.

Option could decrease 

opportunities for differential 

pricing and, hence, efficiency.

Consumers would realize near-term 

benefits at the expense of copyright 

owners. That effect could be mitigated, 

however, if copyright owners were able to 

use digital technologies to enhance their 

ability to produce, market, and distribute 

creative works.

2. See Nick Wingfield, “Shakeout May Mute Music-Download Services,” Wall Street Journal, March 23, 2004.

3. See Mike Godwin, “What Every Citizen Should Know about 

DRM, a.k.a. “Digital Rights Management,” Public Knowledge 

and New America Foundation, Washington, D.C., March 19, 

2004, available at http://www.publicknowledge.org/content/

overviews/citizens-guide-to-drm/attachment; and “Special Report: 

Copy Protection,” IEEE Spectrum, May 2003, pp. 21-35.
30 COPYRIGHT ISSUES IN DIGITAL MEDIA

In many ways, awaiting and then evaluating a marketbased outcome is consistent with copyright law as currently constructed. It leaves the burden of the cost of 

property rights enforcement to the private sector. And the 

copyright conflicts that emerge from the digitization of 

creative content can be adjudicated in a number of ways.

The Digital Millennium Copyright Act, for example, requires the Register of Copyrights to convene an arbitration panel biannually to set Webcasting royalties and to 

conduct a triennial rulemaking process to determine the 

need for new exemptions to certain prohibitions in the 

DMCA. One consideration in determining the need for 

an additional exemption is the “availability for use” of 

copyrighted works—that is, whether the circumvention 

prohibition might restrict access to a copyrighted work 

for which there was no alternative, nondigital source. It is 

reasonable, therefore, that the Congress allow time

Box 4-1.

Internet File-Sharing: Trends and Attitudes

In a survey conducted in February 2004, the Pew Internet & American Life Project and comScore Media 

Metrix found that 18 percent of Internet users said 

that they download music files online, well below the 

29 percent who reported doing so in the spring of 

2003.1

 Because the music downloading activity reported for February 2004 includes not only unauthorized downloads, but also the licensed downloads that 

have become popular only recently, the decline in 

copyright-infringing music downloads might actually 

be larger. During the same 2003-2004 period, the 

number of users of the most popular file-sharing networks fell sharply. The Pew Internet Project’s survey 

also found that 14 percent of Internet users—a share 

that represents more than 17 million people—reported that they had stopped downloading music files 

and that the Recording Industry Association of 

America’s (RIAA’s) June 2003 decision to sue individuals who offer copyright-infringing music files on 

the Internet played some role in that decision. Survey 

respondents who stated that they had never engaged 

in music downloading also acknowledged that the 

RIAA’s lawsuits would deter them from undertaking 

such activity in the future. Groups representing the 

music industry, such as the RIAA and the International Federation of the Phonographic Industry 

(IFPI), point to those results as well as their own research to argue for the efficacy of copyright education 

and enforcement.

In contrast, firms that specialize in tracking Internet 

activity claim that there has not been a substantial 

drop-off in the usage of file-sharing networks. While 

conceding that the RIAA’s legal campaign has had 

some impact on music file-sharing, those firms argue 

that the Pew Internet Project’s survey results were not 

entirely representative of file-sharing activities. For 

example, the Pew survey results were based on phone 

interviews with individuals 18 years and older. Relative to adolescents, who are considered very active 

file-sharers, such respondents would be more likely 

either to have curtailed or, in the context of a phone 

interview, to deny their file-sharing activity as a result 

of the RIAA lawsuits.2 Similarly, comScore Media 

Metrix data on usage of file-sharing networks were 

obtained from consensual monitoring of individuals’ 

computers, which could also lead to an understatement of illicit activity. Internet tracking firms point 

out that their measures, based on anonymous monitoring of Internet traffic, show a 19 percent increase

1. Pew Internet & American Life Project, “The State of Music 

Downloading and File-Sharing Online,” April 2004, available at http://www.pewinternet.org/pdfs/PIP_Filesharing_

April_04.pdf.

2. David McGuire, “Report: Kids Pirate Music Freely,” Washington Post, May 18, 2004.
CHAPTER FOUR ECONOMIC IMPLICATIONS OF PROSPECTIVE LEGISLATIVE ACTION 31

for new business models to emerge before implementing 

legislative remedies.4

The Federal Communications Commission (FCC) may 

also play a role in enforcing copyrights. In November 

2003, the FCC adopted an antipiracy mechanism known 

as the “broadcast flag” to prevent the unauthorized distribution of digital television programs via the Internet. The 

broadcast flag must be implemented by July 1, 2005, on 

equipment that receives over-the-air digital television 

broadcasts.5 That decision followed a standard-setting 

process that enables “plug-and-play” of digital television 

equipment with any cable provider and addresses the 

copy-protection measures that broadcasters of digital television can employ. Under the FCC’s auspices, media and 

technology firms are also negotiating an antipiracy mechBox 4-1.

Continued

in the number of users of file-sharing networks over 

the past year, from 6.8 million in June 2003 to 8.3 

million in June 2004. Further, file-sharing as a proportion of total Internet traffic in the United States 

has declined only slightly, from 70 percent to 65 percent during the past year.

Surveys of attitudes toward file-sharing do not reveal 

a clear picture of the impact of the RIAA’s recent legal actions on the popular perception of its legality. 

According to a survey commissioned by the RIAA, 

the share of respondents in the United States who 

consider unauthorized file-sharing illegal rose from 

37 percent before the RIAA announced its litigation 

strategy in June 2003 to 64 percent by December 

2003. In contrast, a New York Times-CBS News poll 

and a Harris Interactive poll, both conducted in September 2003, found that between two-thirds and 

three-quarters of respondents consider downloading 

or sharing music files for personal use to be “all 

right” or “legal.” Similarly, the Pew Internet 

Project’s February 2004 survey found that 58 percent of those who download music files said that 

they did not care about the copyright on those files. 

However, the same survey also found that 37 percent 

of music downloaders said that they did care about 

whether those music files were copyrighted, up from 

27 percent in Pew’s spring 2003 survey.

Those conflicting survey results may reflect individuals’ unfamiliarity with copyright law. In a tracking 

survey conducted for the Pew Internet Project in

November-December 2003, only 43 percent of respondents claimed that they were “very familiar” or 

“somewhat familiar” with copyright law and regulations. Asked about the fair use portion of copyright 

law in particular, 81 percent of respondents said that 

they were either “not too familiar” or “not familiar at 

all” with it.

Jefferson Graham, “Online File Swapping Endures,” USA 

Today, July 11, 2004; and Will Knight, “Net Traffic Shows 

File-Sharing Undented,” NewScientist.com, May 26, 2004 

(available at http://www.newscientist.com/news/print.

jsp?id=ns99995045).

IFPI Online Music Report 2004, available at http://

www.ifpi.org/site-content/library/online-music-report2004.pdf; Robert Leitman, “Americans Think Downloading Music for Personal Use Is an Innocent Act,” Harris Poll, 

no. 5, January 28, 2004, available at http://www.harrisinter 

active.com/harris_poll/index.asp?PID=434; and Pew Internet & American Life Project, “The State of Music Downloading and File-Sharing Online.” 

Pew Internet & American Life Project, November 2003 

Tracking Survey (publication of results expected in fall 

2004).

4. In October 2003, the Register of Copyrights issued its ruling from 

the latest triennial review. It rejected, among other requests, allowing exemptions to the anticircumvention clause of the DMCA—

17 U.S.C. 1201(a)(1)—for DVD and CD-ROM access controls. 

5. See Federal Communications Commission, Report and Order and 

Further Notice of Proposed Rulemaking, MB Docket 02-230, FCC 

03-273, November 4, 2003, available at http://hraunfoss.fcc.gov/

edocs_public/attachmatch/FCC-03-273A1.pdf?date=31104. 

3.

4.

5.

3

4

5
32 COPYRIGHT ISSUES IN DIGITAL MEDIA

anism for digital television broadcasts that could prevent 

the unauthorized distribution over the Internet of digital 

television broadcasts that could be captured via analog 

outputs and then reconverted into digital format.

Will Markets Increase the Net Social Benefits

of Creative Content?

Whether a new consensus about copyright will set the 

stage for markets to produce efficiency gains and thus net 

social benefits is not clear. Efficiency gains could, but 

need not, be associated with wider applications of those 

strategies in the context of DRM. Consequently, the market-based implementation of DRM technologies that 

would enable differential pricing offers a greater prospect 

of efficiency gains in markets for creative works than was 

possible in the past. From the standpoint of equity, the 

distributional issues described in the discussion of differential pricing remain. However, from a dynamic point of 

view, allowing the market to experiment with different 

business models for the digital provision of copyrighted 

material is likely to be a superior alternative to legislative 

mandates in ensuring that advances in digital technologies provide efficiency as well as increased benefits to both 

copyright owners and consumers.6

Why Forbearance Might Not Work 

Several factors weigh against the success of forbearance as 

an approach to the current copyright debate. First, although differential pricing schemes and the DRM technologies used to implement them may, in theory, offer 

the prospect of greater efficiency in markets for copyrighted works, they may, in practice, prove unsatisfactory. 

The same DRM technology that could allow copyright 

owners to stop the piracy of their works could also be 

used to deny consumers the benefits of the lower reproduction and distribution costs afforded by that technology. If the forces of competition are weak, moreover, producers may not have an incentive to seek returns by 

exploring product variations that match consumers’ willingness to pay. Alternatively, consumers may find that the 

new restrictions on their uses of creative content are unacceptable and attempt to thwart them.7

Some observers argue that if DRM technologies restrict 

consumers’ usage of copyrighted materials in ways that 

stymie consumers’ fair use rights, legislative action will 

probably be required. While U.S. copyright law allows 

for fair use, it does not require owners to facilitate it. Further, because copyright law characterizes fair use in very 

broad terms, its validity in specific instances must be determined legally or legislatively.

Take, for example, a researcher who legally gains access to 

copyrighted material and wishes to make a copy for what 

the user believes is a fair use purpose—archiving a Web 

page for future reference, for instance. If that material was 

copy-protected by some technological measure, the researcher would be forced to either devise or acquire a 

means of circumvention—in the latter case, potentially 

running afoul of the law. If the copyright owner contested the researcher’s use of the material, the researcher 

would have to defend that action legally, and the courts 

would determine whether that particular use of the material qualified as fair use. In those circumstances, however, 

well-funded interests who are better able to participate 

and lobby may eventually prevail and skew the courts’ determinations. As a result of such rulings, individual consumers who wish to make what they believe to be fair use 

of a copyrighted work may simply opt not to do so. 

Other uses of copyrighted material may arise as the applications that enable them emerge. Although copyright law 

may otherwise allow for those uses, DRM technologies 

may restrict them. Indeed, the DMCA prohibits outright 

6. The following excerpt from “Music to Their Ears,” an article in 

The Economist (September 21, 2002), provides a good illustration 

of potential new business models, made possible by applications 

of DRM platforms, that could benefit both copyright owners and 

consumers:

“For example, subscribers to some commercial online-music services are now given the option to send encrypted copies of songs 

to friends. In exchange for the key to unlock the content, record 

labels can choose to charge or give the song away free if the friend 

provides, say, demographic details about himself.

“Another example of DRM in use is Arista’s recently launched web 

channel for fans of the band Boyz II Men. The channel serves up 

unreleased tracks, early access to concert tickets, exclusive videos, 

lyrics and singing lessons from members of the band for an annual 

subscription of $25-35.”

7. Indeed, soon after it patched a flaw that inadvertently allowed 

unauthorized sharing of downloaded files from its popular new 

iTunes online music service, Apple was the target of a successful 

hack, which disabled that patch. Consumer resistance remains, 

and programs that circumvent Apple’s DRM technology continue 

to emerge. See Leander Kahney, “iTunes Music Swap Just Won’t 

Die,” Wired News, June 6, 2003; and Rob Pegoraro, “Restrictions 

and Price Remain iTunes Turnoffs,” Washington Post, April 18, 

2004.
CHAPTER FOUR ECONOMIC IMPLICATIONS OF PROSPECTIVE LEGISLATIVE ACTION 33

circumvention of a technological measure that protects 

access to a copyrighted work, even if access was circumvented to make fair use of the copyrighted material. In 

such scenarios, proponents of consumer rights claim that, 

without legislative intervention, technology could effectively “trump” copyright law.8

A second reason why legislative forbearance may not be 

feasible is that successful application of DRM platforms 

may require much closer monitoring of individuals’ activities online and a consequent loss of privacy. At a spring 

2003 rulemaking by the U.S. Patent and Trademark Office, suppliers of DRM technologies uniformly called for 

strengthening the enforcement provisions of the DMCA. 

It is unclear, however, how much sacrifice of personal privacy is necessary for DRM technologies to work satisfactorily—that is, to prevent enough illicit activity to ensure 

the profitability of supplying creative content in digital 

form. It is also uncertain whether government intervention will eventually be needed to establish the type of personal data that may be collected; how it would be collected, stored, and kept secure; and how it may be used.

Third, unless other countries conform to U.S. copyright 

standards, negotiations on copyright law and enforcement will be necessary to regulate international commerce in digitized creative works. Such international harmonization of copyright law would require legislative 

approval. For example, the Copyright Term Extension 

Act of 1998 brought the term of copyright protection in 

the United States (70 years after death for individual 

copyright owners, and either 95 or 120 years for works 

for hire) into conformance with standards of the European Union (EU) and thereby facilitated reciprocal protection in Europe for works copyrighted in the United 

States.

In addition, the Commission of the European Communities has assessed prospective “rights management” regimes for copyrighted works, which include both compulsory licensing arrangements and DRM systems. The 

Commission concluded that the development of DRM 

systems “should, in principle, be based on their acceptance by all stakeholders, including consumers, as well as 

on copyright policy of the legislature.” Digital copyright 

law in the EU resembles that in the United States; numerous countries, for example, have anticircumvention 

provisions similar to those of the DMCA. However, 

some EU countries, such as Germany and France, grant 

consumers greater personal copying rights than does the 

United States. If the EU and the United States opt to impose different sets of restrictions on consumers’ use of 

DRM-based delivery of digital content, legislation to remove divergences in copyright law could become necessary.9

Extend Compulsory Licensing

to Digital Content

A second approach is for the Congress to set both the 

price of creative content and the terms on which that 

content must be made available. The Congress has had 

considerable experience establishing compulsory and 

other licensing arrangements for copyrighted musical 

works. Once a musical work is recorded, it becomes available for other artists to record upon payment of a set fee 

or royalty. Peer-to-peer advocates have proposed using 

compulsory licensing to compensate recording artists for 

file-sharing and thereby legalize the use of copyrighted 

material on P2P networks.

The rationale for compulsory licensing is that P2P networks will never be sufficiently regulated to allow copyright owners to exercise meaningful control over their 

works once the material becomes available on those networks. A practical means of obtaining compensation for 

copyright owners in that context would be for copyright 

officials to monitor the number of transfers of each copyrighted work among P2P network users. Revenues assessed by either general taxation or levies on the digital 

processing equipment associated with P2P activity could 

8. See the seminal work of Lawrence Lessig in The Future of Ideas 

(New York: Random House, 2001). Indeed, few provisions in 

copyright law currently allow for redress upon copyright owners’ 

making inappropriate use of their rights. One exception is found 

in 17 U.S.C. 512(f), which provides that anyone who knowingly 

misrepresents that material on an Internet network is infringing 

and shall be liable for payment of court costs and damages associated with the Internet Service Provider’s compliance with the 

“notify-and-takedown” requirements of that section of the copyright law. 

9. See Communication from the Commission of the European 

Communities to the Council of the European Parliament and the 

European Economic and Social Committee, “The Management 

of Copyright and Related Rights in the Internet Market,” Brussels, April 16, 2004; and “Part IV: Fair Use Doctrine,” in Berkman Center for Internet & Society, iTunes: How Copyright, 

Contract, and Technology Shape the Business of Digital Media—A 

Case Study (June 15, 2004), available at http://cyber.law.

harvard.edu/media/uploads/81/iTunesWhitePaper0604.pdf.
34 COPYRIGHT ISSUES IN DIGITAL MEDIA

then be distributed to copyright owners according to the 

relative use of their works.10

Furthermore, because technological advances are increasing the diversity of ways in which music, movies, and 

other copyrighted material can be consumed, compulsory 

license fees could potentially reduce transaction costs in 

markets for creative content. The more comprehensive 

the range of uses of copyrighted material permitted under 

a compulsory license for a broad class of creative works, 

the less time consumers would need for reading licensing 

agreements for different copyrighted products within that 

class. In addition, litigation costs incurred obtaining legal 

determinations of copyright infringement would be 

lower, as would the enforcement costs (although those 

cost savings might be reduced by litigation contesting the 

royalty rate).

Setting a fixed price for some types of copyrighted works 

is less efficient, however, than a differential pricing 

scheme. That is because the price of using copyrighted 

material under a compulsory licensing scheme would be 

common not only to all consumers but also to all works 

covered by the license. A single, flat-rate fee is unlikely to 

be “just right” from the standpoint of economic efficiency. Using the framework developed in the previous 

chapter, content prices would not be well matched to 

consumers’ willingness to pay. It is also unclear whether a 

single fee could generate the amount of revenues that 

copyright owners would obtain from differential pricing.

Setting a compulsory license fee could also carry substantial costs, from both administration of the royalty regime 

and losses incurred because of shortcomings in the ratesetting process. For example, registering and tracking the 

usage of copyrighted works accessed on P2P networks 

may be expensive. The process of fixing the compulsory 

license fee may be costly and time-consuming. The process of establishing royalty rates for certain types of Internet music broadcasts, such as nonsubscription Webcasting, dragged on for several years. A contested arbitration 

process to set Webcasting rates gave way to an unpopular 

rulemaking by the Register of Copyrights and, finally, to 

a last-minute, legislatively sponsored agreement among 

the competing groups (which spurred legal action that is 

still ongoing). 

The uncertainty that such a process would engender 

could impede the development of markets for digital 

copyrighted goods subject to those royalty rates. By the 

time the royalty-setting process is completed, moreover, 

the Internet may be sufficiently regulated to enable strict 

copyright enforcement and, in particular, the emergence 

of private-sector licensing and royalty-collection agencies.11 Indeed, the Internet today remains a relatively unregulated environment, and as it is integrated into business and household use, it may well become subject to 

greater control and monitoring.

In addition, the collection and allocation of copyright 

revenues under compulsory licensing could be inequitable. For example, if the compulsory license revenues were 

collected through a levy on computers or other multipurpose digital equipment or media, individuals who do not 

use those products to consume copyrighted works would 

be forced to pay that tax. Among consumers of copyrighted material, those who made the greatest use of the 

digital equipment and media subject to the levy would 

benefit the most.

Revise Copyright Law

Another legislative approach is for the Congress to revise 

copyright law in favor of either copyright owners or consumers. Current copyright law is complex, reflecting the 

cumulative impact of amendments designed to accommodate specific changes in technology. A broad revision 

of copyright law could therefore reduce the losses stemming from uncertainty about its implications. For example, businesses may not offer some types of services involving copyrighted materials, and consumers who fear 

litigation may be reluctant to engage in some uses of such 

materials.

Revise in Favor of Copyright Owners

One option is to restrict the types of uses of copyrighted 

material that currently qualify either as fair use or as an- 10. For examples of compulsory licensing schemes proposed for peerto-peer networks, see Neil Weinstock Netanel, “Impose a Noncommercial Use Levy to Allow Free Peer-to-Peer File Sharing,” 

Harvard Journal of Law & Technology, vol. 17, no. 1 (2003), pp. 1-

84; and William W. Fisher, “An Alternative Compensation System,” in Technology, Law, and the Future of Entertainment (Palo 

Alto, Calif.: Stanford University Press, forthcoming).

11. See the statement of Marybeth Peters, Register of Copyrights, 

before the Subcommittee on Courts, the Internet, and Intellectual 

Property of the House Committee on the Judiciary, March 11, 

2004.
CHAPTER FOUR ECONOMIC IMPLICATIONS OF PROSPECTIVE LEGISLATIVE ACTION 35

other explicit limitation on the exclusive rights of copyright owners. That approach may require consumers to 

pay for some uses of copyrighted material for which they 

currently are not charged. For example, consumers may 

have to pay to make archival copies of computer programs—a practice that copyright law now explicitly allows. Presumably the price for making such copies would 

be set to compensate for the potential losses to software 

manufacturers from unauthorized redistribution.

To the extent that tightening fair use restrictions increases 

price differentiation among consumers, those restrictions 

could also increase efficiency. Indeed, some commentators argue that the rationale for fair use comes not from 

efforts to balance private incentives and societal benefits 

but rather from attempts to minimize the transaction 

costs of obtaining authorization to use copyrighted material in particular ways. From that perspective, improvements in communications technologies and data delivery 

may have an unintended consequence: fair use may no 

longer be needed as a remedy for such costs.12

However, copyright law makes explicit allowance for fair 

use in activities such as criticism, comment, news reporting, teaching, scholarship, and research, where the benefits to society presumably outweigh the revenues denied 

to copyright owners. Restricting fair use in those applications may not produce as great an increase in efficiency as 

in other applications because some socially beneficial uses 

of copyrighted material could become prohibitively expensive.

The potential difficulties of setting new prices for some 

uses of copyrighted material also argue against tightening 

fair use too much or too rapidly. The music industry continues to experiment with setting prices for online music 

downloads, for example, even though the product is welldefined and has been marketed in other formats for many 

years.13

Such pricing difficulties may arise when the value of consumer uses is difficult to determine for technological reasons. For example, purchasers of computer software inscribed on a CD-ROM may wish to be able to make a 

backup copy in case the original disc becomes damaged 

or turns out to be defective. Because such digital media 

are relatively new, their durability is still uncertain. If a 

CD-ROM deteriorates materially and the software program stored on it becomes inaccessible, a backup copy 

could turn out to be unexpectedly valuable; conversely, 

the value of a software program that could not be archived could turn out to be unexpectedly low.14

Finally, where competitive pressures on markets for copyrighted works are weak, the efficiency of differential pricing schemes could be compromised if fair use was sharply 

curtailed. That situation could occur when consumer valuations are determined by “versioning”—that is, setting 

prices that vary across groups of consumers on the basis 

of each group’s shared use of a particular version of the 

same product. In those circumstances, the supplier may 

have an incentive to take a “damaged goods” approach, in 

which a low-cost version of a product is purposely made 

inferior to induce customers to purchase a higher-quality 

variant.

For example, some railroads in the 19th century put 

third-class carriages toward the front of the train, which 

exposed passengers to cinders from the engine compartment. That strategy was designed to force all those who 

could afford to pay more into the more comfortable firstand second-class carriages.

Economic efficiency in those outcomes is compromised 

because the characteristics and price of the lower-quality 

variant are set not to respond to demand in the low willingness-to-pay market niche but rather to motivate customers to opt for variants of higher quality and price. To 

the extent that fair use is restricted and consumers of

12. See Benjamin Klein, Andres V. Lerner, and Kevin M. Murphy, 

“The Economics of Copyright ‘Fair Use’ in a Networked World,” 

American Economic Review, vol. 92, no. 2 (May 2002), pp. 205-

208. For a defense of fair use in spite of reduced transaction costs, 

see Ben Depoorter and Francesco Parisi, Fair Use and Copyright 

Protection: A Price Theory Explanation, Working Paper No. 01-03 

(Arlington, Va.: George Mason University School of Law, 2001).

13. See Ethan Smith, “Downloading Music Gets More Expensive,” 

Wall Street Journal, April 7, 2004; and Amy Harmon, “What Price 

Music?” New York Times, October 12, 2003.

14. See Peter Svensson, “CDs and DVDs Not So Immortal After All,” 

Associated Press, May 6, 2004.
36 COPYRIGHT ISSUES IN DIGITAL MEDIA

copyrighted material can enjoy only a few uses of a creative work at no cost, copyright owners could likewise 

manipulate the product spectrum.15

Another way to revise copyright law in favor of copyright 

owners would be to strengthen the anticircumvention 

and enforcement provisions of copyright law to prevent 

consumers from using copyrighted products in ways for 

which they had not paid. Again, to the extent that such a 

measure would increase differential pricing, economic efficiency would be increased. 

How those particular anticircumvention and enforcement provisions would be implemented, however, requires careful consideration. Recent legislation has envisioned two approaches: mandating use of a specific 

technology to ensure the security of creative works in digital format (S. 2048);16 and providing a limited liability 

for copyright owners who access the computers of individuals suspected of copyright infringement to identify 

and disable infringing material (H.R. 5211).17

From the perspective of efficiency, technology mandates 

could stymie innovation. Forcing new digital technologies to conform to a particular security standard for digital content, for example, could impede the development 

of superior products. Likewise, consumers’ concerns 

about the ability of copyright owners to exploit a safe harbor to gain access to their computers could deter individuals from using and experimenting with the Internet.

From the point of view of equity, a technology mandate 

could impose costs on either manufacturers of digital 

hardware and software or purchasers of that equipment. 

If the mandated copyright protection technology is 

thwarted, the cost of developing that technology may be 

unrecoverable. If existing digital products are rendered 

obsolete by the mandated technology, costs would be imposed on consumers of existing products. In the case of a 

safe harbor, owners of computers would be forced to 

share some burden, in the form of potential damage to 

their equipment from online enforcement efforts, so that 

copyright owners could protect their property.

Other types of enforcement measures could, if poorly designed, have detrimental impacts on both efficiency and 

equity. For example, not all copyright owners may wish 

to prevent the same type of unauthorized uses of their 

creative works. The Supreme Court wrote in its Sony v. 

Universal Studios decision that, unlike copyright owners 

in the movie industry, some owners of copyrights on television broadcasts may in fact have wanted viewers to be 

able to make unauthorized tapes of their programming to 

expand the broadcast’s audience. Declaring manufacturers of videocassette recorders liable for copyright infringement would have protected the rights of copyright holders in the movie industry at the expense of copyright 

owners in other media. Similarly, a poorly designed enforcement measure could deprive some copyright owners 

of the ability to make their content as widely available to 

consumers as they may wish. Such a measure would introduce inefficiency because some copyright owners and 

consumers would be deprived of supplying and consuming, respectively, copyrighted material at a cost that each 

party was willing to bear. It would also be inequitable, 

since one group of copyright owners would benefit at the 

expense of other copyright owners and consumers.

Revise in Favor of Consumers

Several bills have proposed expanding the rights of consumers of creative content. For example, H.R. 1066 

would significantly expand limitations on the exclusive 

rights of copyright owners.18

Expanding fair use could be detrimental to efficiency. If 

copyright owners were able to charge differentially for 

fewer types of uses of their material, they would have to 

raise the price on those uses for which they could charge. 

Those higher prices could prohibit consumption of that 

material by some consumers. The decrease in overall receipts to copyright owners could also reduce the supply of 

creative works if creators no longer had sufficient resources to devote to their efforts.

Many popular movies, for example, are expensive to produce. A significant share of movie industry costs are covered by sales and rentals of DVDs, which constitute an 

15. See Andrew Odlyzko, “Privacy, Economics, and Price Discrimination on the Internet,” July 27, 2003, available at http://

www.dtc.umn.edu/~odlyzko/doc/privacy.economics.pdf.

16. Consumer Broadband and Digital Television Promotion Act, 

107th Cong., 2nd sess.

17. To Amend Title 17, United States Code, to Limit the Liability of 

Copyright Owners for Protecting Their Works on Peer-to-Peer 

Networks, 107th Cong., 2nd sess.

18. Benefit Authors Without Limiting Advancement of Net Consumer Expectations (BALANCE) Act of 2003, 108th Cong., 1st 

sess. 
CHAPTER FOUR ECONOMIC IMPLICATIONS OF PROSPECTIVE LEGISLATIVE ACTION 37

estimated half of current movie industry revenues. If 

movie studios were unable to price differentially for 

movie viewing by making their products available on 

DVD or in some other form, the price of admission at 

the box office would—holding everything else constant—have to increase to compensate for those lost revenues.

However, technological advances in the future may enable copyright owners to devise new business models to 

accommodate the diminished control they could exercise 

over their intellectual property. Advances in information 

technology may facilitate the development of new business models by allowing some copyright owners to enjoy 

cost savings or new opportunities for production, marketing, and distribution, which could offset losses of revenue.

Software companies, for example, abandoned a strategy 

of trying to thwart and prosecute infringers and instead 

opted to encourage licensed use by providing users with 

product updates and customer service. Similarly, recording companies could evolve from artistic development 

and marketing enterprises to businesses that help music 

listeners navigate through a catalog of essentially selfproduced artists. Because of advances in digital recording 

techniques, the recording companies of the future could 

assist consumers both in finding matches for their existing music preferences and in developing new ones. Television broadcasters and moviemakers could make up for 

losses of traditional advertising or royalty receipts by increasing the supply of television-on-demand and using 

information gained in providing that service to focus and 

improve advertising efforts.

From the standpoint of equity, the effects of revising 

copyright law in favor of consumers of creative material 

would be to transfer control from copyright owners to 

consumers. However, for some incumbent copyright 

holders, losses suffered from diminished control over 

their creative works may already have been compensated, 

at least in part, by recent legislation that extended the duration of copyright protection.19

When considering any legislative option for revising 

copyright law—whether one of those discussed in this paper or some other option—it is important to be mindful 

of the possibility that a modification to copyright law 

could well have unintended consequences. Any revisions 

that are undertaken, therefore, require careful deliberation.

19. See AEI-Brookings Joint Center for Regulatory Studies, “The 

Copyright Term Extension Act of 1998: An Economic Analysis,” 

Brief 02-1 (May 2002); and Mark A. Lemley, “Ex Ante Versus Ex 

Post Justifications for Intellectual Property,” University of Chicago 

Law Review, forthcoming.