Information Goods

Slide 1:Information Goods

All products contain some degree of information. Entertainment products contain a higher degree of information and smaller component of physical inputs than most other products. That is one reason that digitization is so common for entertainment products. You can�t digitize a car or refrigerator. The Internet Economy is particularly suited to the transmission of information goods. First module is a review of Useful Economic Concepts that you may or may not have had in the past (in MECO 6201, which you should have had).

Slide 2:Some Useful Economic Concepts

Elasticity Price Discrimination Public (Information) Goods Consumer and producer surplus Fixed and Variable Costs

Slide 3:Price Elasticity Of Demand

def: percentage change in quantity divided by percentage change in price (?Q/Q)/(?P/P) or (?Q/?P) (P/Q) measure of responsiveness If Elasticity is >1 known as elastic (responsive customers) If Elasticity is =1 ; unit elastic If Elasticity is <1; inelastic (less responsive customers) Infinite and zero elasticity

Slide 4:Illustrations of elasticity

Slide 5:Elasticity and TR

When elasticity is greater than 1 (elastic) increases in price lead to decreases in revenue and vice-versa When elasticity is equal to 1, changes in price lead to no change in revenues When elasticity is less than 1 (inelastic) increases in price lead to increases in revenue.

Slide 6:Implications of Elasticity

If Elasticity is <1, firm can always increase Profit by increasing price (revenues increase and costs decrease because output decreases) If Elasticity =1, firm can always increase profit by increasing price If Elasticity>1 firm can not necessarily increase its profits by a change in price. Thus firms that maximize profits must have elasticities >1. Example of VideoTape Sales Demonstrates Importance of knowing elasticity.

Slide 7:Why is Windows so Cheap?

Elasticity indicates that Windows is grossly under-priced relative to short run monopoly price. Find it hard to believe? Check out the analysis for yourself.

Slide 9:Consumer and Producer Surplus

Consumer surplus is the difference between the price paid and the higher price that consumers would have been willing to pay for the product. Producer surplus is the difference between the payment received and the minimum payment that producers would have accepted.

Slide 10:Consumer and Producer Surplus

Q1 4 3 DWL = 3+4

Slide 11:Monopoly Vs. Competition

Monopoly versus competition Smaller Quantity Higher Price Price discrimination. The tradeoff associated with patents and copyright - deadweight loss in consumption versus possible new products.

Slide 12:Monopoly charges higher price, produces smaller quantity.Monopoly causes Deadweight Loss 1+2. Area 3+4 is transfer to producer from consumer

MC

Slide 13:Fixed And Variable Costs. Fixed Costs: Costs that do not change when output changes. Creation of a recording master Creation of a movie, developing software, writing a book. Variable costs: Costs that do change when output changes. Marketing, distribution,

The Role of fixed and Variable Costs

Slide 14:The Role of fixed and Variable Costs

Why are these costs important? Entertainment products are high fixed cost/low variable cost items. This implies some unusual characteristics of the industry. To maximize profits, firms maximize revenues. Elasticity equals one. Leads to �natural monopoly� type of result.

Slide 15:Typical Product

AVC AC Fixed and Variable Costs AFC P Q q1

Slide 16:Typical Entertainment Product

AVC AC Fixed and Variable Costs AFC P Q q1

Slide 17:Price Discrimination

Perfect Two or More Markets Bundling and Block Booking Versioning

Slide 18:Perfect Price Discrimination

Theoretical ideal. Cannot be fully achieved. Find maximum price that every consumer is willing to pay and charge them that price. Requires more information than any firm has, and the prevention of arbitrage. Demand Curve becomes MR curve. No Deadweight Loss. Approximate examples: automobile dealers, doctors in the old days.

Slide 20:Price Discrimination - 2 or more Markets

If markets for a single product have different MRs, profits can be increased by shifting output from low MR markets to high MR markets. Raise price in low MR market and lower price in high MR market. High MR market is high elasticity market. Need to Prevent Arbitrage. Examples: Airlines with business travelers and vacationers. Coupons.

Slide 22:Price Discrimination Rules

Raise price in market with lower elasticity (lower responsiveness) Lower price in market with higher elasticity. Do this until MRs are equalized. But prices will not be equalized. Examples: Airlines with business travelers and vacationers.

Slide 23:Examples of Price Discrimination

Movies (adults, children, seniors) Movies: theatrical release, pay per view, dvd, cable, television Books: Hardcover and paperback Software: full versus �lite� versions

Slide 24:Price Discrimination Law

Illegal if it gives some firm an advantage over other firms. If individuals are consumers, is not illegal. Price Discrimination is not likely to harm efficiency. Perfect Price discrimination is perfectly efficient. Intention of this rule was to protect �mom-and-pop� stores and grocers from department stores and supermarkets. It was intended to reduce competition.

Slide 25:Versioning

Sometimes (frequently) creating different grades of products might just better meet consumer demands. Versioning is artificially creating different products (where the high end product would meet all needs) to achieve price discrimination. Problem: avoiding cannibalization of higher end product line.

Slide 26:Versioning Examples

Luxury versus regular automobile brands. PC Junior. �lite� versions of software with reduced functionality. Putting identical chips in high and low powered calculators.

Slide 27:Bundling (Block Booking)

Two or more products that are sold as a package. CDs versus singles Cable television bundles versus a la carte. Subscription services versus pay per use �cable blanket versus long distance telephone or pay per view; Rhapsody versus iTunes. Computers with software Office suites versus individual components.

Slide 28:When Bundling Works Best

Slide 29:Successful Bundling Makes Demand More Homogeneous

Qx Px Py Qy Px+y Qx+y

Slide 30:Advantage of a Bundle

The Matrix Green Tomatoes X Y 2000 1900 1300 1200 Bundle 3200 3200 2 x 1300 2 x 1200 5000 6400

Slide 31:Issues with Bundling

Telephone service � consumers presumably preferred certainty of unlimited local calls as opposed to pay per call. Not a �bundling� issue per se, but a psychological one. CDs versus singles- pricing versus cannibalism. iTunes versus prior models. Cable television bundles versus a la carte. There are some political moves afoot to force a la carte service. Why, and what would be the impact?