Chris Anderson’s latest article in Wired is titled Free! Why $0.00 is the Future of Business. As I’ve talked about before, Chris’s basic argument is that marginal costs in IT are so low and dropping so fast that giving stuff away for free can make sense as a business model.

As he says, many costs in Internet markets look like fixed costs rather than marginal costs. So the marginal cost to Google of providing an extra web search is practically nil. But there are still massive fixed costs. Google runs thousands of servers in gigantic data centers. They use so much electricity that they’re investing in new electricity generation technologies, and they use so much bandwidth that they’re investing in a new trans-Pacific fiber-optic cable.

Anderson paints the trend towards free as being wonderful for consumers, and it is wonderful that I can do Google searches for free. However, when all costs are fixed and none are variable, we have a classic case of economies of scale. The big guy has the lowest average cost, and it’s hard for smaller guys to compete. Lack of competition is bad for consumers. In the search market, searchers don’t pay, but advertisers do. When we take the welfare of advertisers into account, it’s not clear that the economic outcomes in the search market are so wonderful after all. [However, Hal Varian disagrees that economies of scale are the source of Google’s high market share in search.]

Chris also has some wacky economic logic at some points. Check out this quote:

Two of the main scarcity functions of traditional economics — the marginal costs of manufacturing and distribution — are rushing headlong to zip. … Surely economics has something to say about that? It does. The word is externalities, a concept that holds that money is not the only scarcity in the world. Chief among the others are your time and respect, two factors that we’ve always known about but have only recently been able to measure properly.

Money is not a resource, money is just an illusion that we use to trade things. The concept of externalities is not that other things are scarce, but that people’s private actions often have effects on others which they don’t take into account. What I think Chris is really trying to say is that attention and reputation are scarce (I agree), and firms that give something away for free are not competing in price but rather in these other dimensions. Google and the other search engines compete in terms of reputation and attention on the searcher side of the market, and compete in price on the advertiser side of the market.

I’m not saying that Free! is totally wrong. I’m just saying that Free! makes for a great headline, but I don’t see anything intrinsically ‘good’ about it. Having all costs fixed and none variable does not necessarily generate an efficient market structure. And it could be that free web searchers with paid advertising is not the socially optimal pricing structure, once we take all welfare sources into account.