
Intangible investment behaves differently - ZeljkoS
https://www.gatesnotes.com/Books/Capitalism-Without-Capital
======
losvedir
_There are two assumptions you can make based on this chart. The first is
still more or less true today: as demand for a product goes up, supply
increases, and price goes down. If the price gets too high, demand falls._

Er, no. I guess even smart people like Gates get simple economics wrong
sometimes. It's understandable, though, I've always felt the P/Q axes should
be switched, since people always speak about the price as the independent
variable.

He's conflating the idea of pricing _along the line_ with the demand line
itself. Yes, at higher prices, less quantity is demanded and vice versa.
Similarly, if you can sell the thing for a higher price, more people will be
interested in and able to sell it, so the quantity available will increase,
and vice versa.

However, "supply" and "demand" refer to the whole lines themselves, not points
along the lines. Changing supply and demand means the lines shift. If "demand
for a product goes up", the demand line shifts to the right, the equilibrium
quantity increases, but _so does the price_ , the opposite of what he's
saying.

His misconception then leads to an even larger error in understanding with the
next part:

 _The second assumption this chart makes is that the total cost of production
increases as supply increases._

This is false. What it says is that with if the price you can get for a good
is high there will be more suppliers. The canonical example is oil: when it
sells for $20/barrel, only Saudi Arabia and places with it easily accessible
will be able to profitably drill for it, and so the quantity supplied will be
low. But at $120/barrel, you can now use fracking, deep water drilling, and
other much more expensive processes, and so the quantity supplied will be
higher.

Supply and demand is not about any _individual_ producer producing more, and
so it's not particularly useful in analyzing the behavior of a single firm.
It's about the aggregate effect of multiple different parties, each with their
own respective infrastructures and costs, profitably contributing to the
supply (or not) at different price points.

~~~
crazygringo
1) Everything you say is correct, and I have no idea why you're being
downvoted.

2) In my experience, the supply+demand curve is one of the most misunderstood
concepts in economics, and it took me a long time in college until I found an
economics professor who could explain it properly. A lot of really intelligent
people I know don't understand it (even though they think they do), and in my
experience most business people don't actually understand it (that's fine,
they don't usually need to), but I am fairly shocked to see Gates
misunderstand it... unless this article is written by an intern or something,
which I find more likely.

~~~
TeMPOraL
RE 2), could you share your understanding, or point towards some resources
that would let me check if my understanding is correct?

~~~
crazygringo
The Wikipedia article is a good start:

[https://en.wikipedia.org/wiki/Supply_and_demand](https://en.wikipedia.org/wiki/Supply_and_demand)

It does a good job of getting into and linking to its nuances, although it's
not exactly a tutorial or anything.

------
sytelus
When I first learned that software had a price during my very young years, I
was in quite disbelief. Isn’t it just bunch of invisible bits? Can’t it be
copied with almost zero cost? Why someone would pay for it anyway when kids
like me can make it? It’s hard to charge money for things people can’t
physically posses. In early years, almost all software companies employed a
trick to design big attractive boxes with bit of goodies. When Gates wrote
BASIC, many programmers themselves in the community didn’t thought _any_
software was worth paying for. It has taken almost a generation to internalize
that bits have price and we have got rid of most of those boxes finally.

On the side note, crypto currency is the new new intengible assets that is
hard to internalize. Ironically, Gates has wrote them off as not worth calling
them assets because they aren’t store of a value.

~~~
MoBattah
Elaborate on the boxes? This isn't the old trope by Bob Wallace about 'I sell
manuals'?

~~~
LeifCarrotson
[https://i.ebayimg.com/images/g/azAAAOSwD99av12v/s-l1600.jpg](https://i.ebayimg.com/images/g/azAAAOSwD99av12v/s-l1600.jpg)

There's a shrink-wrapped cardboard package that contains Windows 98. It's the
size of a cereal box, and at least as colorful.

Today, I'd be intensely annoyed if I had to wait for and pay for a large box
to ship - I'd much prefer an instant download, but the box was much more
tangible than an email with a download link and license key.

~~~
interfixus
At the time of Windows 98 you probably wouldn't have wanted to download the
damn thing. If you are of a younger generation, you may not believe it, but
many of us in those days made do with something called dial-up connections to
the internet. I well remember downloading the StarOffice - precursor to
LibreOffice - suite in the days before it was taken over by Sun, meaning 1999
at the latest. Took a little over five hours, and was done at night when rates
were lower. I actually stayed up, nursing the process along. And afterwards
guarded the downloaded installation file, almost with my life, although it
took up an inordinate amount of precious storage space. It was 50MB and a bit,
you see.

~~~
techopoly
Ah yes, the memories of those agonizingly slow (and noisy) Internet
connections. Ironically, software, particularly games, still can take 5 hours
to download. It's just that they're inordinately huge now. Battlefield 1 with
its patches can run over 110 GB.

------
LeifCarrotson
> _Imagine Ford releasing a new model of car. The first car costs a bit more
> to create, because you have to spend money designing and testing it. But
> each vehicle after that requires a certain amount of materials and labor.
> The tenth car you build costs the same to make as the 1000th car._

As someone with software and hardware at Ford in Dearborn and at many of their
suppliers, this is not true. Ford knows that the costs decrease over time, and
demands part of this cut from their suppliers. The contract includes a
decreasing price over time or over quantity, because ostensibly you're
increasing efficiency and writing off initial engineering costs.

I imagine that Microsft does the same with their hardware division, and agree
with the sibling comments that Gates probably did not write all of this.

------
crazygringo
_Who_ exactly isn't paying attention? Gates never says. I don't know anyone
who is reasonably educated in business/economics who doesn't understand the
software/publishing business model, which is taught... literally everywhere. I
seriously have no idea what he's arguing against.

Even with the supply curve, real-world commercial software virtually always
has unit costs. It generally takes marketing and/or sales to acquire new
customers, ongoing server and storage costs, customer support... and ongoing
bugfixes and improvements merely to _remain_ competitive and not fall behind
in the market.

When Microsoft calculates the profitability of Word, their costs aren't
"virtually free" or anywhere even close to that.

~~~
pwang
I was first annoyed at the amateur level of analysis in this piece. "Um, it's
2018, open source software runs production workflows in every single business;
if you don't realize yet that every industry in the world is being reduced to
becoming a commodity machine to run business rules & agreements as fluid
software, then you're about 5 years behind the curve."

Then I realized it was written by Bill effing Gates. And that made me feel
sad.

Firstly, because Bill is smarter than this. His lack of awareness of just how
pressing this phenomenon is, indicates that he's either had his head in the
sand, or the intellectual circles he swims in hasn't been ringing the alarm
bells about this. (See my essay on the Changing Nature of Scarcity:
[https://medium.com/@pwang/the-changing-nature-of-scarcity-
fc...](https://medium.com/@pwang/the-changing-nature-of-scarcity-
fcc09049fbae))

Secondly, because of the irony. Bill Gates made his fortune having created a
business around selling software. It would be good for him to review John
Perry Barlow's "Selling Wine Without Bottles":
[https://www.eff.org/pages/selling-wine-without-bottles-
econo...](https://www.eff.org/pages/selling-wine-without-bottles-economy-mind-
global-net)

As the world's first and most successful wine bottler, billg might find this
perspective illuminating.

~~~
ethbro
YMMV, but aside from anyone that started in the Google & Facebook area, huge
swaths of the economy are still dominated by closed source software.

From personal experience, this covers: any kind of software-driven hardware,
health care, tax, CAD, POS, finance, transportation, & retail.

They're changing. But I'd estimate most Top 500 companies are at 0-25% open
source migration of _core_ business processes.

------
Peopleguyintech
I generally agree with Gates on a lot of things, but there are some
generalizations here that don't apply to a lot of software.

1\. While the cost to produce N+1 and N+1000 version of the software is same
in terms of producing the code, if you have a piece of software that functions
more like a specialized tool, training user N+1 and N+1000 can be radically
different and therefore more time consuming and costly.

2\. Sunk cost of development: IP has a lot of value. If you work in producing
custom solutions a lot of these solutions have components (code) that work
across customer needs. Development may fail on one project, but helps in
another. Overtime you have the components to sell a COTS

3\. Goods actually aren't intangible, value is. Electricity costs money and it
takes the infrastructure to support a small city to run a large-scale server
farm. What's missing in the economic model are the costs we don't always
factor in or more importantly that are publicly subsidized. Look at the breaks
companies get at MSoft, Google, etc on utilities and land.

~~~
sharemywin
The laws have be setup so, all the value is trapped in the giant network
companies. No liability for content. No portability requirements(you can port
your phone number, but not your data or messaging addresses). Rent seeking is
blocked for utilities, so they don't capture it from google, facebook etc..

------
orbifold
The fact that replicating a piece of software or music digitally has near zero
cost suggests that the fair price according to classic economic theory is zero
(the argument being, that the price in a competitive market should approach
the limit price). Of course what we see instead is a lot of companies that are
now rent seeking and that no longer sell a piece of software to you but rent
it out for a fixed price (SaS, Adobe Creative Cloud, Jetbrains, season passes
in games etc.), similarly with DRM and Music/Movies/eBooks
Spotify/Netflix/Amazon. Uber also fits this pattern in that they rent out
capital that other people provide to them for free (insane if you think about
it).

What hopefully will happen over time is that these rent seeking entities are
squeezed out of the market over time, otherwise we are entering an area of
corporate feudalism. This can be prevented as long as the assets needed for
production are easily and cheaply available, which is the case thanks to the
Free Software Movement.

~~~
bsbechtel
I think you are confusing the definition of rent seeking, meaning achieving
economic gains by means of regulation that is virtually risk free, with
collecting rent as a form of payment for a service or product. These are two
different concepts, despite the name they share.

~~~
syrrim
"rent seeking", in economics, is not limited to regulation. We would
distinguish between those who earn money by creating new value - as the
inventor makes some process more efficient, and so makes his living - and
those who earn a living despite creating no value. The easiest example of this
is the man who has inherited some plot of land, and rents out the plot to
someone. He might earn a healthy living - but where has he created value? The
strongest example of this is perhaps he who earns money by destroying value -
say the window repairman who goes out at night and smashes windows - but this
is not required to be classed as rent seeking.

------
rcdmd
This book review has a few economic fallacies and was probably not written by
Gates. But, these points are interesting--

"It" refers to "intangible investment" here--

1\. It’s a sunk cost. If your investment doesn’t pan out, you don’t have
physical assets like machinery that you can sell off to recoup some of your
money.

2\. It tends to create spillovers that can be taken advantage of by rival
companies. Uber’s biggest strength is its network of drivers, but it’s not
uncommon to meet an Uber driver who also picks up rides for Lyft.

3\. It’s more scalable than a physical asset. After the initial expense of the
first unit, products can be replicated ad infinitum for next to nothing.

4\. It’s more likely to have valuable synergies with other intangible assets.
Haskel and Westlake use the iPod as an example: it combined Apple’s MP3
protocol, miniaturized hard disk design, design skills, and licensing
agreements with record labels.

~~~
jerf
"This book review has a few economic fallacies and was probably not written by
Gates."

Dunno if they're fallacies so much as oversimplifications. But the
oversimplifications aren't really the point; they're just meant to reference
the concepts and give a hyper-quick overview if you've never heard of them.
The rest of the review remains a valid point if you substitute more realistic
economic concepts. This is my pre-emptive reply to the inevitable dozens of
posts arguing about the oversimplifications. None of it matters to the point
the author wanted to make.

Note I say "valid", not correct. Whether economists are undervaluing
intangible assets is a rich and interesting question that I have only vague
opinions about personally. I'm just pointing out that the argument itself does
not depend on the oversimplified economic concepts used to introduce the
point.

~~~
rcdmd
You're right to say it's mostly oversimplifications. The fallacy was the first
economic concept introduced in the article--

> The first is still more or less true today: as demand for a product goes up,
> supply increases, and price goes down.

Classic econ teaches as demand increases, prices go up. The exception is if
the supply curve is flat (for instance, 0 marginal cost).

~~~
jerf
Sorry, yes, you have a point there. I missed that.

------
ggambetta
> it combined Apple’s MP3 protocol

WTF, seriously?

~~~
zwily
Yeah, seems unlikely that he wrote this.

~~~
Shivetya
It could simply be either from the study he mentioned or be worded as such to
make it easier for non technical people to understand, as in more are familiar
with MP3 than AAC. It is irrelevant to the greater point of the article

~~~
ggambetta
I'm sure a man as smart as Bill Gates could find a way to write it in a way
that is accessible to non-technical people and still not so egregiously
factually incorrect.

~~~
melling
Here’s another discussion of the book that discusses the same book and
example.

[https://www.imperial.ac.uk/business-
school/knowledge/finance...](https://www.imperial.ac.uk/business-
school/knowledge/finance/rise-intangible-economy-capitalism-without-capital-
fostering-inequality/)

He’s just using the example from the book and doesn’t feel the need to restate
it?

~~~
dwighttk
Gates' says "it combined Apple's MP3 technology...", your example says "Apple
combined MP3 technology..."

------
madengr
“It’s a sunk cost. If your investment doesn’t pan out, you don’t have physical
assets like machinery that you can sell off to recoup some of your money”

That also means it’s cheaper to develop. Software is so popular since it’s
only requires a developer and a PC. The return/investment is a lot higher and
faster than traditional hardware development. Cheap and fast is what everyone
wants.

Of course investors are now realizing, in the case of self driving cars (or
cars themselves with Tesla), that hardware still plays a role, and it’s not
cheap and fast with instant riches.

20 years ago, biotech was supposed to be the hot thing after the internet.
Instead it has been software services, focusing on service labor. Biotech is
not cheap and fast enough.

~~~
npsomaratna
^ Exactly.

Also, his statement implies that digital assets have no real-world financial
value. In practice, even if the investment fails, the codebase of the company,
body of active users, and any user data gathered will have some value.

------
SQL2219
Plenty of people are paying attention,and Gates contradicts his own title with
this sentence:

"The portion of the world's economy that doesn't fit the old model just keeps
getting larger." How can it get larger if no one is paying attention?

~~~
maxerickson
You've substituted "no one" for "not enough" in order to gin up your pedantry.
The title is "not enough".

Or do you think the phrases mean the same thing?

~~~
mmirate
"Not enough" and "nothing" are usually very difficult to distinguish, since
they usually have largely the same effects.

(e.g. it doesn't matter if I have insufficient money or no money at all; life
sucks in both of those alternate-universes)

~~~
BoiledCabbage
> since they usually have largely the same effects.

They absolutely don't. I'd you have "not enough money" to meet your current
monthly budget that means you can't afford to put anything aside for your
vacation next year but can still get by.

If you have "no money", you can eat or pay your rent.

The two phrases have entirely different meanings, and usually with important
differences in connotation.

------
ProAm
Wasnt this discussed yesterday:
[https://news.ycombinator.com/item?id=17761257](https://news.ycombinator.com/item?id=17761257)

------
sonnyblarney
1) The first two paragraphs about 'assumptions' are essentially false. There
are no assumptions in supply and demand, it's not a dynamic equilibrium, it's
a snapshot.

Yes - over time supplies tend to change due to demand, of course, but that's
'long run' stuff ... not in that chart. The author is kind of misinterpreting
the chart.

2) It's not 'sunk cost' that's the issue, this is about 'fixed' vs. 'unit'
cost. Software is all 'fixed' (i.e. setting up the production line) whereas
most material things are mostly about 'unit' costs (i.e. the cost to make an
item)

3) Software sales are a tiny fraction of the economy because _almost nobody is
selling software_. People are selling 'services', basically products that 'do
stuff using software'.

The 'key ingredient' is usually some type of business or experiential
knowledge, not some algorithm.

4) Software development doesn't finish at v1, it's ongoing.

~~~
pjc50
> There are no assumptions in supply and demand, it's not a dynamic
> equilibrium, it's a snapshot.

It absolutely is an equilibrium in normal economics:
[https://en.wikipedia.org/wiki/History_of_microeconomics](https://en.wikipedia.org/wiki/History_of_microeconomics)

~~~
sonnyblarney
Assumption 1 from article:

"demand for a product goes up, supply increases, and price goes down"

Assumption 2 from article:

"The second assumption this chart makes is that the total cost of production
increases as supply increases. Imagine Ford releasing a new model of car. The
first car costs a bit more to create, because you have to spend money
designing and testing it. But each vehicle after that requires a certain
amount of materials and labor. The tenth car you build costs the same to make
as the 1000th car"'

In assumption 1 - he's not describing how equilibrium works at all.
Equilibrium is the price the market will clear at given a supply and demand
curve. If 'demand goes up' \- given a fixed supply demand curve ... 'price
goes up'. So what the author must be referring to is some kind of market
response, i.e. if demand is increasing for something, more suppliers will come
along and build it, create more competition, and drive prices down. This has
little to do with the Supply/Demand curve.

I don't even know what assumption 2 is about, I get what he is saying but it
has nothing to do with supply and demand curves.

Anyhow - even if there is logic in his statements, neither assumption is drawn
from the Supply and Demand curve he is showing.

~~~
nostrademons
He's referring to the static equilibrium in assumption 1. Supply & demand
curves, as drawn in economic textbooks, refer to _marginal_ supply and
_marginal_ demand. The X-axis is is quantity, so what the graph is saying is
that producing 100,000 units of some good is assumed to cost more than
producing 10,000 units, and similarly consumers will be more willing to buy
10,000 units than 1,000 units at a given price (the Law of Downward-Sloping
Demand, for those who remember their intro microec).

With assumption 2, he's saying that in software (and many other businesses
now), supply curves do not necessarily slope upwards. For software, producing
100,000 units takes exactly as much money as producing 1,000 units, and can be
offered at the same cost.

The author (who is Bill Gates, BTW, and can be assumed to know a thing about
microeconomics) only alludes to this and doesn't say it outright, but there
are a number of knock-on consequences to flat supply curves that explain much
of the counterintuitive properties of the tech industry but aren't well-
explained by classical economics. For example, the "lottery economy" aspect
(where there is one company that ends up dominating a market and the size of
that company is dictated only by the size of the market) comes from zero
marginal costs: once a software firm has built a solution that satisfies a
market, there is nothing stopping it from expanding to serve _the whole_
market far faster than any competitor can enter. The existence of the VC
industry follows from this, because when success is binary and can't be
interfered with once discovered, it makes sense to spread capital across a
number of bets, hoping for a hit, rather than rationally analyze how much
additional return invested capital will give in an existing business.

Google & Facebook's dominance also stems from this zero-cost-of-production
property. When your cost of production _to provide the good or service_ is
zero, then the only thing blocking your continued expansion is finding &
convincing potential customers. With CAC forming an increasing percentage of
your total marginal costs, any services that lower it or make it scale better
can realize huge profits.

~~~
partiallypro
> _For example, the "lottery economy" aspect (where there is one company that
> ends up dominating a market and the size of that company is dictated only by
> the size of the market) comes from zero marginal costs: once a software firm
> has built a solution that satisfies a market, there is nothing stopping it
> from expanding to serve the whole market far faster than any competitor can
> enter._

I'm not sure what you mean, this is 100% covered in general economic theory
with barriers to entry.

> _Google & Facebook's dominance also stems from this zero-cost-of-production
> property. When your cost of production to provide the good or service is
> zero_

But it's actually not 0 or even close to it. There are still economies of
scale at play, if Facebook were to lose millions of users their costs would
grow per user, which is what a marginal cost curve represents. Just because
the curve is different doesn't mean it doesn't exist.

I'm pretty disappointed with Gate's post, because every academic economist I
know is mocking it...since it's not well represented or thought out. It
ignores so many principles and theories in economics for the sake of being
"ground breaking." Even though most of the theories are hundreds of years old
and still apply completely.

------
Terretta
TL;DR: Actually, read this longer thing:

[https://smile.amazon.com/Capitalism-without-Capital-
Intangib...](https://smile.amazon.com/Capitalism-without-Capital-Intangible-
Economy-ebook/dp/B071P3VGHQ/)

------
mathattack
I think his straw man for supply and demand is off. Higher demand doesn’t
create lower prices. Lower prices creates “more quantity demanded” at a given
level. If demand increases, then prices and quantity both go up. This may be
semantics, but it isn’t like economics completely falls apart. Similarly,
economics is able to handle products with high fixed and low marginal costs.
(Natural monopolies)

I suspect he gave this book review assignment to an intern that majored in
something besides CS, business or Econ.

~~~
BoiledCabbage
That's bothered me before. It really seems like economists flipped their axes
on a basic supply demand curve.

They discuss it as if price is the independent variable and quantity (demanded
or supplied) is the dependent, and yet any 9th grader would be marked down for
putting their independent variable on the "y-axis".

It amazes me how something generally accepted as wrong stays that way.

~~~
grosjona
I had the same thought. Also, I'm not even sure that this diagram makes sense
overall because supply, demand and price are so tightly interconnected (with
feedback loops in both directions) that it doesn't make sense to separate them
like this.

~~~
losvedir
> _Also, I 'm not even sure that this diagram makes sense overall because
> supply, demand and price are so tightly interconnected (with feedback loops
> in both directions) that it doesn't make sense to separate them like this._

How so? Econ major here, and I agree the axes should be swapped, but I don't
follow your other point.

~~~
grosjona
Why is it that when the price drops, consumers would want to buy more and
producers would necessarily want to produce less?

If I was a company director and the price of the commodity that I produced
dropped by a lot, I would work harder to produce more of the commodity to
offset the lower profit margins; that way I could earn the same bonus at the
end of the year in order to make the payment for the mortgage on my yacht.

Also in the case of cryptocurrencies, it doesn't seem to work the way the
graph suggests; when the price goes up, people buy more.

~~~
losvedir
Ah, I think you have the same misconception as Gates in the post, of confusing
the concepts of "points along the curve" with the curve itself.

> _Why is it that when the price drops, consumers would want to buy more and
> producers would necessarily want to produce less?_

I would phrase it as when the price is lower, there are more consumers who
would buy, and fewer producers to sell. To take the demand curve, for example,
it doesn't explain _one person 's_ behavior at different prices. Rather, think
of the curve as a thousand points, each representing a different person and
their own _maximum_ price at which they would buy the item. The supply curve
is a thousand producers each with the _minimum_ price they'd be willing to
operate at.

> _If I was a company director and the price of the commodity that I produced
> dropped by a lot, I would work harder to produce more of the commodity to
> offset the lower profit margin_

Yes, this is already reflected in the supply curve. If your company is able
and willing to produce that commodity at a lower price, you're already
reflected on the supply curve as one of the points on the line below the
current equilibrium price. You have what's called a "producer surplus" if
you'd be willing to produce at a lower price than the equilibrium.

Take the supply of uber drivers for example. If the price of rides decreases,
you may to some extent see drivers adjusting how much they drive, but the main
effect is to remove drivers from the market who have better uses of their
time, less efficient cars, etc. Similarly, if the price _increases_ you'll see
new uber drivers coming online driving their clunky SUVs or whatever.

Or, in the case of cryptocurrency, the supply follows this as well: at a
higher price, less efficient miners or people in locations with higher utility
prices will be able to profitably mine, and so the number of people supplying
computation will increase.

> _Also in the case of cryptocurrencies, it doesn 't seem to work the way the
> graph suggests; when the price goes up, people buy more._

This, too, works with the supply and demand curves, when you understand them
properly. The concept at work, here, is that changing supply or demand (i.e.
think of the thousands of people that make up each curve shifting their
preferences in the aggregate) represents _shifts_ of the curve, not movements
along it. Increased demand is the curve shifting up and/or to the right (it's
the same thing).

So, when the price goes up, people see it in the news and have FOMO and so
"demand increases", meaning the curve shifts to the right. If you look at the
graph again, you'll see that means the equilibrium price _increases_ , which
is what's happening. That, in turn, drives more breathless speculation and
aggregate demand increases again, pushing the curve further to the right,
driving up the price some more.

Concept check: the supply curve is not _shifting_ , here. Per my earlier
paragraph, the increasing price may mean more miners come online, but that's
already what the supply curve means. A shift in the supply curve would be
something like a new breakthrough energy technology making everyone's
utilities cheaper. That means if everyone's minimum price before was $x,
they're now willing to supply computation at $x + 5, shifting the supply curve
to the right and (if you check the diagram) driving down the equilibrium price
(since the # of bitcoins in circulation will increase faster and the demanded
fee by the miner's will be less).

~~~
grosjona
Makes more sense how you explain it, thanks.

------
evrydayhustling
This title is kind of uninformative .. how about "the rise of intangible goods
requires different economic models"?

~~~
hestefisk
Click bait title.

------
TheBeardKing
It's ok to editorialize the title when it's this click-baity, right?

------
ProfBernardo
Page doesn't load content area. Adblockers doing their job. :-)

~~~
icebraining
Loads fine with uBlock Origin on, but not without JS, despite the content
being in the HTML :| Firefox's Reader mode can pull it out, though.

