Ever since the introduction of Napster, the impact of file sharing on the music industry has been the focus of intense debate. The availability of songs on file sharing networks has two competing effects on sales that are likely to vary across artists. First, there is a direct substitution effect on sales as some consumers download rather than purchase music. Second, there is a penetration effect which increases sales, as the spread of an artist’s works helps to make the artist more well-known throughout the population. The first effect is strongest for ex ante well-known artists, while the second is strongest for ex ante unknown artists. Thus file sharing reduces sales for well-known artists relative to unknown artists. Taking account of this heterogeneity in estimating the effect of file sharing provides strong evidence of this distributional effect. Additionally, I find a large aggregate negative effect on sales not apparent in previous work that failed to account for the differential impacts on more and less wellknown artists. The overall negative impact of file sharing arises because aggregate sales are dominated by sales of well-known artists. Using my estimates of the effect of file sharing, counterfactual exercises suggest that the lawsuits brought by the RIAA have resulted in an increase in album sales of approximately 2.9 % during the 23 week period after the lawsuit strategy was publicly announced. Furthermore, if files available on-line were reduced across the board by 30%, industry sales would have been approximately 10 % higher in 2003.

The current conflict between the recording industry and a portion of its customers who are involved in illicit copying of music files arose from innovations involving the compression and electronic distribution of files over the internet. This paper briefly describes some of the challenges faced by the recording industry, and examines some of the ethical issues that arise in various industry and consumer responses to the opportunities and threats presented by these innovations. The paper concludes by highlighting the risks associated with responses that threaten further innovation, ultimately reducing the chances of finding solutions that hold appeal for all parties.

Financial support from the Deutsche Forschungsgemeinschaft through SFB/TR 15 is gratefully acknowledged. Sonderforschungsbereich/Transregio 15 · www.gesy.uni-mannheim.de