"If something is free to reproduce and distribute, the marginal cost for an additional good is zero, so new entrants simply reduce the profit they take until the price of the good stabilizes at its lowest possible price (the bottom)"

The problem with this fallacy is that it doesn't capture the 'cost' of the good which involves creativity and implementation, combined with a system of copyrights. So while it may be true that a generic good like a text editor might reach a price point near the cost of maintenance, something like AngryBirds generates revenue over a longer life cycle. Things that people want, they pay money for if they cannot get value out of a 'free' offering. Capturing that value requires understanding a bit about what the actual user value is and how they weight it, but as we read in another set of comments about people weighing the pros and cons of an app vs plonking down $5 for a cup of coffee without even batting an eye, the market for coffee is mature, people know what they are going to get for their $5 so the value proposition is in the bag, not so with Apps yet, and perhaps not for many years yet. But that education process continues.