However, when it comes to books, I'm not convinced that prices always drive down. (It's possible economists are laughing at me right now.) But as I tried (badly) to explain on Konrath's blog, I think price pressure can also drive prices up.
Suppose the consumer has a flat budget of $10 and a choice between two books, a $10 book by Author A and a $1 book by Author B. If books were completely interchangable, the consumer would always choose the $1 book. But we know that books are not completely interchangable. Let's say that the consumer prefers the $10 book, and so buys that one. The consumer will not have enough money left to buy the $1 book, despite how cheap it is. The author of the $10 book makes $7. (I am assuming both authors are indie and make 70% royalty.)
Now suppose the consumer does buy the $1 book. This author, however, only makes $.70. (Actually, it is worse, because on Amazon right now this author will only make $0.35). So even if the cheap book beats out the expensive book 9 times out of 10, the author of the $1 book will only make $6.30 for every $7.00 the other author makes. At the lower royalty rate, the difference is even more stark. The author makes only $3.15.
If all authors charge $1, then all consumers can buy 9 extra books. The consumer can buy Author A and Author B. So instead of 9 sales, the author with the lower price makes 10 sales, which, at least if royalties were at $.70, is equal to selling one book at $10. For consumers, this is a much better situation, obviously. So maybe all books will float down to the $1 price, as music and games have.
But what if price is not the only restraint?
If the consumer could buy 10 $1 books, but actually has time to read only one, then lowering the price is not a smart move for authors. Even if the consumer buys more books than can be read, say, 3 instead of 1, this does not make up for the loss to the author.